##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended April 2,
    2006                                                 
|          
|          
|          
|          
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from          to          .                                   

Commission file number: 0-50387

RedEnvelope, Inc.

(Exact name of Registrant as Specified in Its
Charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|                                                                  
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|                                                                  
|Delaware                                                           |  | 33-0844285                              
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (I.R.S. Employer
    Identification No.)

149 New Montgomery Street, San Francisco, California
94105

(Address of Principal Executive Offices and
Zip Code)


(415) 371-9100

(Registrants Telephone Number, Including
Area Code)


Securities registered pursuant to Section 12(b) of the
Act:

None


Securities registered pursuant to Section 12(g) of the
Act:



Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the
Securities
Act.    Yes o         No þ

Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or
Section 15(d) of the
Act.    Yes o         No þ

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.    Yes þ         No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K.    o

Indicate by check mark whether the registrant is
a large accelerated filer, an accelerated filer or a
non-accelerated filer. See definition of accelerated
filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.

Large Accelerated
Filer o         Accelerated
Filer o         Non-Accelerated
Filer þ


Indicate by check mark whether the registrant is
a shell company (as defined in Rule 12b-2 of the
Act).    Yes o         No þ

The aggregate market value of the voting stock
held by non-affiliates of the Registrant as of
September 30, 2005, was approximately $32.3 million
based upon the last sale price reported for such date on the
Nasdaq National Market.

The number of outstanding shares of the
registrants common stock, $0.01 par value per share,
was 9,462,010 as of June 21, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Parts II
and III of this Report, to the extent not set forth herein,
is incorporated herein by reference from the registrants
definitive proxy statement relating to the annual meeting of
stockholders to be held in 2006, which definitive proxy
statement shall be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year
to which this Report relates.



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RedEnvelope, Inc.

TABLE OF CONTENTS TO FORM 10-K

For Fiscal Year Ended April 2, 2006


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|Item 1.       |  | Business                                                                                                             |    |      | 2  | 
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|Item 1A.      |  | Risk Factors                                                                                                         |    |      | 8  | 
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|Item 1B.      |  | Unresolved Staff Comments                                                                                            |    |      | 23 | 
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|Item 2.       |  | Properties                                                                                                           |    |      | 23 | 
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|Item 3.       |  | Legal Proceedings                                                                                                    |    |      | 23 | 
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|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                                              |    |      | 23 | 
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|PART II      
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|Item 5.       |  | Market for Registrants
    Common Equity, Related Stockholder Matters and Issuer Purchases
    of Equity Securities |    |      | 24 | 
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|Item 6.       |  | Selected Financial Data                                                                                              |    |      | 25 | 
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|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                            |    |      | 25 | 
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|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risk                                                       |    |      | 34 | 
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|Item 8.       |  | Financial Statements and
    Supplementary Data                                                                      |    |      | 36 | 
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|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                             |    |      | 53 | 
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|Item 9A.      |  | Controls and Procedures                                                                                              |    |      | 53 | 
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|Item 9B.      |  | Other Information                                                                                                    |    |      | 53 | 
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|PART III     
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|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                                               |    |      | 55 | 
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|Item 11.      |  | Executive Compensation                                                                                               |    |      | 55 | 
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|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management                                                   |    |      | 55 | 
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|Item 13.      |  | Certain Relationships and
    Related Transactions                                                                   |    |      | 55 | 
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|Item 14.      |  | Principal Accountant Fees
    and Services                                                                           |    |      | 55 | 
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|PART IV      
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|Item 15.      |  | Exhibits and Financial
    Statement Schedules                                                                       |    |      | 56 | 
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|Signatures    |  |                                                                                                                      | 59 |     
|EXHIBIT 10.46
|EXHIBIT 10.56
|EXHIBIT 10.57
|EXHIBIT 10.58
|EXHIBIT 10.59
|EXHIBIT 10.60
|EXHIBIT 10.61
|EXHIBIT 10.62
|EXHIBIT 10.63
|EXHIBIT 10.64
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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PART I






|        |         
|------- | --------
|Item 1. | Business

This Annual Report on Form 10-K and the documents
incorporated herein by reference contain forward-looking
statements based on expectations, estimates and projections as
of the date of this filing. Actual results may differ materially
from those expressed in forward-looking statements. See
Item 7 of Part II  Managements
Discussion and Analysis of Financial Condition and Results of
Operations  Forward-Looking Statements.

Overview

RedEnvelope is a branded online retailer of upscale gifts,
dedicated to helping its predominantly female customers
celebrate and nurture their most important relationships with
unique gifts and unequalled gift-giving experiences. RedEnvelope
offers an extensive and fresh collection of imaginative and
original gifts through our catalog, web store and phone store.
We strive to maintain the highest standards for product
distinctiveness, quality and value, gift delivery, gift
presentation and customer service, in an effort to provide our
customers and their recipients with the best possible gift
giving experience. We believe this provides the foundation of
our repeat business. We have developed an internal database of
approximately 2.9 million customer names, with
approximately 574,000 new customers added in fiscal 2006.

We strive to offer a wide assortment of quality, thoughtful
gifts, many of which are difficult to find elsewhere and are not
easily replicated. Our in-house design team creates unique
proprietary products, and our merchants source products
domestically and from various parts of the world, often
commissioning artists and vendors to create exclusive gifts. Our
gift wrap is distinctive and closely associated with our brand.
Gift-wrapped products are delivered to the recipient in a
branded, high-quality red box with a hand-tied ivory ribbon. We
offer a wide assortment of products in fourteen categories with
the majority of products ranging in price up to $150. Our core
product categories include jewelry, home, mens and
womens accessories and new baby gifts.

Through our web store, www.redenvelope.com, customers can
search for gifts by occasion, recipient, product category and
price point. Our web store generally features approximately 700
to 750 products, increasing to over 800 products during the
holiday shopping season. In addition, through our web store, our
customers can register for our gift reminder service, sign up to
receive email promotions, view their order history, chat live
with a customer service representative and request a catalog. In
fiscal 2006, approximately 80% of customer orders were placed
through our web store with the remainder placed through our
phone store. We also publish our full-color catalog several
times during the year. Each catalog generally features
approximately 130 products, increasing to approximately 235
products during the holiday shopping season. The catalog also
serves as the primary direct marketing channel and advertising
vehicle for our web store and phone store. During fiscal 2006
and 2005, we mailed approximately 30.8 million and
25.8 million catalogs, respectively. We also sell directly
to corporate clients through our Business Gift Services
(BGS) group. BGS leverages our existing merchandise
assortment to help businesses with their holiday giving, as well
as other corporate gifting needs during the year.

We currently intend to focus on the following strategies:



| |   |                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Focus our strategic attention on the relationship-building
    essence of gift-giving  by better understanding
    our customers relationships and recipients, and by
    providing gifts, gift reminders and gift services that help them
    celebrate their closest personal relationships                        
|
| |  | Simplify our business  by concentrating on our
    core female customers, their core relationships and recipients,
    their most important recurring gift giving occasions, and the
    core product categories we believe they prefer for celebrating
    these occasions with their inner circle family and friends
|
| |  | Execute with excellence  by implementing a
    more disciplined approach to financial and operations
    management, including tight cost controls and inventory
    management                                                                                                                                       

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| |   |                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Improve marketing efficiency  by increasing
    our focus on generating repeat purchases from existing customers
    through increased relevance and increasing the efficiency of our
    customer acquisition efforts
|
| |  | Continue distinctive product innovation  by
    continuing to refresh our product offering each season                                                                                                                

RedEnvelope, Inc. was incorporated in California in June 1997
under the name Giftworks Online, Inc. and changed
its name to 911 Gifts, Inc. in December 1997. We
reincorporated in the State of Delaware under the name 911
Gifts, Inc. in March 1999 and changed our name to
RedEnvelope, Inc. in September 1999. We made an
election to be treated as an S Corporation for federal and
state tax purposes, which remained in effect through
February 28, 1999, the day prior to our reincorporation in
the State of Delaware. We completed our initial public offering
in September 2003, and our common stock is listed on the Nasdaq
National Market System under the symbol REDE.

Recent Events

On May 16, 2006, we announced that the Company has engaged
WR Hambrecht & Co as our financial advisor to assist in
exploring strategic alternatives to maximize stockholder value,
including, but not limited to, the possible sale to, or merger
of the business with, another entity offering strategic
opportunities for growth. However, there can be no assurances
that the exploration of strategic alternatives will result in a
transaction. For a discussion of these and other risks, see
Item 1A  Risk Factors. We do not
intend to disclose developments with respect to the exploration
of strategic opportunities unless and until the Board of
Directors approves, and the Company executes a definitive
agreement for, a specific transaction.

Merchandising and Sourcing

Our merchandising group has been designing and developing new
products since 2001, as well as purchasing new products from
outside sources. Our merchandising group meets regularly with
our product development and sourcing teams to review product
opportunities, product quality and customer feedback. From these
meetings, ideas for proprietary products are put into design
development. Our sourcing department then places and manages the
production of these products, largely with overseas
manufacturers. In addition, our merchants and sourcing
department works with vendors to develop exclusive products that
have unique and innovative features or concepts that we believe
distinguish us from our competitors. We believe that the appeal
of our proprietary and exclusive products is a key factor as we
strive to broaden our customer base, strengthen and enhance our
brand appeal, and improve our gross margins.

During fiscal year 2006, approximately 59% of our products,
representing approximately 69% of our revenues, can be
characterized as proprietary; that is, designed and developed by
our in-house team. Our sourcing group works directly with
international manufacturers, importers and overseas agents to
purchase or manufacture our products. During fiscal 2006, we
sourced overseas approximately 54% of our products, representing
approximately 62% of our revenues. While products sourced
overseas typically have lower costs, leading to higher product
margins, such products may contain higher inbound freight and
duty costs. Increasing security expenses, fuel costs and demand
for shipping capacity may result in higher inbound freight costs
than we have anticipated. Increasing competition for overseas
production resources, particularly in China, may result in
higher than anticipated product costs and lower product margins.

We believe that working directly with overseas agents and
manufacturers allows us to more effectively manage product
development and quality. Since, however, we do not have
long-term arrangements with any vendor, manufacturer or
distributor that guarantees the availability of products, we do
not have a predictable or guaranteed supply of products in the
near future. In addition, while our product development process
includes sampling products for quality, there remains the
possibility that final production runs will include products
that do not meet our quality standards. If we fail to obtain
sufficient quantities of inventory, it would have a harmful
effect on our business, financial condition and results of
operations. We have received in the past, and may receive in the
future, shipments of products from manufacturers that fail to
conform to our quality standards. In such event, unless we are
able to obtain replacement products in a timely manner, we may
lose sales which could harm our business and operating results.
For a discussion of these and other risks related to our
fulfillment and distribution operations, see
Item 1A  Risk Factors.

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Further, in recent years, U.S. companies have been subject
to port strikes, which delayed the delivery of goods. As we
increase our overseas sourcing, we face the risk of these
delays, which could harm our business. Due to the lead times
associated with overseas production, we may not be able to
receive adequate levels of products that meet our quality
standards. If we are unable for any reason to provide our
customers with continued access to adequate levels of appealing
products that meet our quality standards, our operating results
would be harmed.

We cannot predict whether any of the countries in which our
merchandise currently is manufactured or may be manufactured in
the future will be subject to additional trade restrictions
imposed by the U.S. and other foreign governments or what the
likely effect of such restrictions could be. Trade restrictions,
including increased tariffs or quotas, embargoes, and customs
restrictions, against items that we offer or intend to offer to
our customers, as well as U.S. or foreign labor strikes,
work stoppages or boycotts, could increase the cost or reduce
the supply of items available to us and adversely affect our
business, financial condition and results of operations. Our
sourcing operations also may be adversely affected by political
and financial instability resulting in the disruption of trade
from exporting countries, significant fluctuation in the value
of the U.S. dollar against foreign currencies, restrictions
on the transfer of funds and/or other trade disruptions. For a
discussion of these and other risks related to our merchandising
and sourcing operations, please see
Item 1A  Risk Factors.

Marketing

Our marketing efforts principally focus on a portfolio of online
channels, catalog circulation, e-mail deployment, and public
relations initiatives. We have an internal database of
approximately 2.9 million customer names, of which 32%
represents our active twelve month customer file as of
April 2, 2006. Revenues from online channels, specifically
portals, search (including natural and paid search) and
affiliates (including revenue sharing arrangements), increased
by 24% over the prior fiscal year. Revenues from customers who
received our catalogs or emails grew approximately 11% over the
prior year. We currently expect this trend of slower catalog
growth to continue. The increases in our online, catalog and
email channels were partially offset by a decline in revenues
from customers that order directly through our web store without
an apparent connection to our catalog, online, email or
corporate marketing activities. In fiscal 2007, we plan to
continue our marketing efforts through online channels, catalog
circulation, and e-mail deployment. Rather than increasing
catalog circulation, we plan to increase the efficiency of our
current circulation by focusing on the most efficient retention
and acquisition catalog customers. We also plan to market our
products and brand with a focus on generating repeat purchases.
For example, during fiscal 2006, we developed a loyalty program,
called Red Box Rewards, and a new e-mail welcome marketing
program, designed to stimulate additional purchases from new
customers.

Currently, we believe the increase in commerce over the Internet
will continue for the foreseeable future. However, if consumers
are unwilling or unable to use the Internet to purchase retail
products due to infrastructure problems, security concerns or
otherwise, our business would be harmed. In addition, our
competitors have increased their use of online marketing
campaigns, and the cost of online marketing programs has
increased. Moreover, software programs that block certain email
marketing campaigns have gained in popularity with individuals.
The federal government and certain states have enacted
legislation specifically prohibiting or placing significant
restrictions on email marketing campaigns. These trends could
negatively impact our ability to market to customers through
online marketing campaigns which could harm our business. For
discussion of these and other risks related to our marketing
operations, see Item 1A  Risk
Factors.

Fulfillment and Distribution

We lease and operate an approximately 240,000 square foot
warehouse and fulfillment facility in Lockbourne, Ohio. We hold
our inventory at this facility and ship most of our merchandise
directly from this facility to our customers. Customer orders
are downloaded to the fulfillment center after they have been
approved for shipment. Orders are then filled and audited for
accuracy and quality before final processing. Product assembly
and personalization, such as engraving and embroidery, is also
performed at our fulfillment

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Customer Sales and Service

We lease and operate an approximately 13,000 square foot
customer sales and service center in San Diego, California.
We are committed to providing our customers with courteous,
knowledgeable and prompt service 24 hours a day, seven days
a week. Our customer sales and service group in San Diego
provides personal attention to customers who call toll free, use
Internet chat, or send emails to place orders or inquire about
products. Our customer sales and service group is also
responsible for addressing customer concerns promptly in an
attempt to achieve the customers complete satisfaction. We
seek to provide a superior customer experience and therefore, if
a gift recipient is not satisfied with one of our products
(except, under certain circumstances, personalized products),
they can return the product for repair, replacement or refund at
any time.

We seek to hire and retain qualified customer sales and service
representatives and train them thoroughly. Training for customer
sales and service representatives focuses primarily on acquiring
a working knowledge of our products and of developing an
understanding of our high customer sales and service standards.

Our customer sales and service operations are subject to a
number of risks, including disruptions due to power outages,
telecommunications or computer system failures, natural
disasters and other catastrophic events or an inability to
maintain proper levels of competent staffing, the occurrence of
any of which could seriously harm our operations. For a
description of these and other risks related to our customer
sales and service operations, see Item 1A 
Risk Factors.

Competition

We operate in a highly competitive environment. We principally
compete with a variety of department stores, Internet retailers,
specialty retailers and other catalog merchants that offer
products similar to or the same as our products. Increased
competition could potentially result in price reductions,
reduced gross margins and loss of market share, any of which
could seriously harm our net revenues and results of operations.
We expect competition to intensify in the future because current
and new competitors can enter our market with little difficulty
and can launch new websites at a relatively low cost. We
currently or potentially compete with a variety of companies,
including:



| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | other online retailers, such as Amazon.com and eBay                                                                                                                                                               
|
| |  | major department stores, such as Macys,
    Bloomingdales, Neiman Marcus and their online
    storefronts                                                                                                       
|
| |  | physical and online stores and catalog retailers that sell
    popular gift items such as Pottery Barn, Brookstone, The Sharper
    Image, Tiffanys, Harry & David, J Crew,
    1-800-Flowers and Williams-Sonoma
|
| |  | Internet portals and online service providers and other
    comparison shopping sites, such as AOL, Yahoo! and Google.                                                                                            

Many of our traditional store-based, catalog-based and online
competitors have longer operating histories, larger customer or
user bases, greater brand recognition and significantly greater
resources, particularly financial and marketing resources. Many
of these competitors can devote substantially more resources to
website development and catalog retailing than we can. In
addition, large, well-established and well-financed entities may
establish more robust online sales operations in the future. Our
competitors may be able to secure products from vendors on more
favorable terms, provide popular products to which we do not
have access, fulfill customer orders more efficiently and adopt
more aggressive pricing or inventory availability policies than
we can.

The U.S. retail industry, the specialty retail industry in
particular, and the online commerce sector are highly
competitive, dynamic in nature and have undergone significant
changes over the past several years and will likely continue to
undergo significant changes. Our ability to anticipate and
respond successfully to these

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Intellectual Property and Proprietary Rights

We regard our trademarks, copyrights, domain names, trade
secrets and other intellectual property as critical to our
success. We rely on various intellectual property laws and
contractual restrictions to protect our proprietary rights.
These include copyright, trademark and trade secret laws and
confidentiality, invention assignment and nondisclosure
agreements with our employees, contractors, suppliers and
strategic partners. Despite these precautions, it may be
possible for a third party to copy or otherwise obtain and use
our intellectual property without our authorization.
RedEnvelope and certain other trademarks for our
business either have been registered or registration
applications are pending with United States Patent and Trademark
Office and with certain foreign registries. Effective
intellectual property protection may not be available in every
country in which our products and services are made or will be
made available online. If we are unable to protect or preserve
the value of our intellectual property for any reason, our
business would be harmed.

We also rely on technologies and other intellectual property
that we license from third parties. These licenses may not
continue to be available to us on commercially reasonable terms,
or at all, in the future. As a result, we may be required to
develop or obtain substitute technology of lower quality or at
greater cost, which could materially adversely affect our
business, operating results and financial condition. For a
discussion of risks related to intellectual property, see
Item 1A  Risk Factors.

Information Technology and Systems

We use third party information technology systems for
fulfillment, order management, merchandising, financial
reporting and in our website. In addition, we have internally
developed significant portions of our website and integrated
that with these other systems. We are continually making
modifications to our overall technology infrastructure in an
effort to improve the shopping experience and order fulfillment
capabilities. We currently license and use Manhattan
Associates Warehouse Management System for fulfillment,
Mail Order and Catalog System (MACS) as our order and
inventory management system and Oracle Financials for financial
reporting. Our website currently incorporates software licensed
from Broadvision, Inc. We may use other third-party information
technology systems in the future.

Our information technology systems are housed in a leased
third-party facility in San Francisco, California, which
was moved from Santa Clara, California in July of 2005.
Data is stored in a database that runs on a redundant server and
storage array. We also have standby servers that can provide
additional capacity as necessary. The facility hosting our
servers provides redundant heating, ventilation, air
conditioning, power and Internet connectivity. The redundant
data center that we had in Cincinnati, Ohio is in the process of
being eliminated. We currently plan to establish a failover
system at our primary data center for all of our production
systems during the second quarter of fiscal 2007, although we
currently believe that this will not occur prior to the
elimination of the Cincinnati, Ohio facility. There can be
no assurances that we will accomplish this task in this
timeframe or at all. For a discussion of these and other risks
related to our information technology systems, see
Item 1A  Risk Factors.

We are currently planning on implementing new software programs
for our website and inventory planning functions in fiscal years
2007 and 2008. We currently believe the implementation of these
software systems will better support the needs of our business
and customers. Software implementation projects entail
significant technical and business risks, and we cannot provide
assurance that such projects will be completed successfully or
within our time and cost expectations. If we are unsuccessful in
implementing these systems, it may hinder our ability to process
and fulfill customer orders as well as complete critical
financial processing transactions. These projects will result in
uses of cash and additional depreciation expense.

Our ability to receive and process orders successfully through
our website is critical to our success and largely depends upon
the efficient and uninterrupted operation of our computer and
communications hardware and software systems. Our systems and
operations are vulnerable to damage or interruption from power
outages, computer and telecommunications failures, computer
viruses, security breaches, catastrophic events

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Seasonality

Our business is highly seasonal, reflecting the general patterns
of peak sales for the retail industry during the holiday
shopping season. Historically, a substantial portion of our net
revenues occur during the third fiscal quarter ending around
December 31. We generally experience lower net revenues
during the first, second and fourth fiscal quarters and, as is
typical in the retail industry, have incurred and may continue
to incur losses in these quarters. In anticipation of increased
sales activity during the third fiscal quarter, we incur
significant additional expenses, including significantly higher
inventory and staffing costs. Due to the seasonality of our
sales, our quarterly results will fluctuate, perhaps
significantly. In addition, similar to many retailers, we make
merchandising and inventory decisions for the holiday season
well in advance of the holiday selling season. Accordingly,
unfavorable economic conditions or deviations from projected
demand for products during the third fiscal quarter could have a
material adverse effect on our business, financial condition or
results of operations for the entire fiscal year. For a
discussion of these and other risks related to the seasonality
of our business, see Item 1A  Risk
Factors.

Employees

As of April 2, 2006, we employed approximately
210 full-time employees. Additionally, we hire seasonal
employees, temporary employees and use temporary employment
agencies during the peak seasons. We have never had a work
stoppage, and none of our employees are represented by a labor
union. We consider our employee relationships to be positive. If
we are unable to recruit and retain key employees or if we are
unable to maintain adequate staffing of qualified employees,
particularly during peak sales seasons, our business would be
affected adversely. For a discussion of these and other risks
related to our employees, see Item 1A 
Risk Factors.



| |                                     
| | ------------------------------------
| | Executive Officers of the Registrant

The following table sets forth certain information regarding our
executive officers and key employees as of June 29, 2006.

|                         |  |     |    |             |  |                                                
|------------------------ |  | --- | -- | ----------- |  | -----------------------------------------------
|Name                     |  | Age |    | Position(s)
|                         |  |     |    |            
|                        
|                        
|                        
|                        
|Kenneth Constable        |  |     | 55 |             |  | Chief Executive Officer, President and Director
|                        
|                        
|                        
|                        
|Polly E. Boe             |  |     | 51 |             |  | Chief Financial Officer and Secretary          
|                        
|                        
|                        
|                        
|Frank Buettner           |  |     | 51 |             |  | Chief Operating Officer                        
|                        
|                        
|                        
|                        
|Gary M. Korotzer         |  |     | 43 |             |  | Chief Marketing Officer                        
|                        
|                        
|                        
|                        
|Christopher E. Nordquist |  |     | 40 |             |  | General Counsel                                

Kenneth Constablehas served as the President, Chief
Executive Officer and a member of our Board of Directors since
February 2006. Prior to joining RedEnvelope, Mr. Constable
served as Senior Vice President/ General Manager of Provide
Commerce, the leading e-commerce marketer of fresh flowers,
where he was responsible for the overall strategic direction,
accelerated growth, and financial performance of the ProFlowers
business unit. Mr. Constables prior experience
includes serving as Vice President/ General Manager of Dell,

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Polly E. Boehas served as Chief Financial Officer of
RedEnvelope since April 2005. Prior to joining the Company, from
July 2001 to April 2005, Ms. Boe was the Chief Financial
Officer of Sundance Catalog, a specialty direct retailer located
in Salt Lake City, Utah. From March 1999 to June 2000,
Ms. Boe served as the Chief Financial Officer of Esprit de
Corp., a branded apparel retailer and wholesaler. From
1978-1998, Ms. Boe held several positions at Levi
Strauss & Co., including the Vice President, Finance of
Levi Strauss Americas and of Levi Strauss USA and Vice President
of Planning and Performance of Levi Strauss North America.
Ms Boe is a certified public accountant and holds a BBA from the
University of Texas at Austin.

Frank Buettnerhas served as our Chief Operating Officer
since February 2006. Prior to joining RedEnvelope,
Mr. Buettner served as Vice President of Operations and
Information Technology for Bag Borrow or Steal, an early stage
Internet company. Prior to this, Mr. Buettner was the Chief
Information Officer/ Chief Operating Officer at Nordstrom
Direct., where he was responsible for all fulfillment
operations, customer sales and service centers, and IT
initiatives. Before Nordstrom Direct, Mr. Buettner spent
20 years at Lands End, most recently as Vice
President of the international division, where he was
responsible for the retailers subsidiaries in Japan,
Germany and the UK.

Gary M. Korotzerserved as Vice President of Marketing
since January 2005 and was appointed Chief Marketing Officer in
February 2006. Prior to joining RedEnvelope, Mr. Korotzer
served in several senior marketing positions at Charles Schwab
and Company from 1997 to 2003, most recently as Senior Vice
President, Mass Affluent Marketing. From 1994 to 1997 he served
as Director, Customer Development at Qwest Communications. Prior
to that, he held marketing management positions with American
Express from 1989 to 1994. Mr. Korotzer holds a BS in
Business Administration from Lewis and Clark College and an MBA
in Marketing and International Business from New York
Universitys Stern School of Business.

Christopher E. Nordquisthas served as General Counsel
since October 2003. Prior to joining RedEnvelope, from June 2001
to October 2003, Mr. Nordquist served as Chief Operating
Officer of Asset Management Business at Thomas Weisel Partners,
an investment bank, and from July 2000 to June 2001 as General
Counsel of an asset management joint venture between Thomas
Weisel Partners and Scudder Investments. From January 2000 to
July 2000, he served as General Counsel at WR Hambrecht, an
investment bank. From July 1998 to January 2000, he served as
General Counsel of Esprit de Corp., a clothing retailer. From
1994 to 1998, he was Senior Counsel at Barclays Global
Investors, an institutional asset management firm. Prior to
Barclays Global, he practiced law with the Shearman &
Sterling and Howard, Rice law firms. Mr. Nordquist received
a BA in Economics from St. Olaf College and a JD from the Boalt
Hall School of Law of the University of California at Berkeley.






|         |             
|-------- | ------------
|Item 1A. | Risk Factors

You should consider carefully the risks and uncertainties
relating to our business including those described below,
together with all of the other information included or
incorporated by reference in this Annual Report on
Form 10-K. Additional risks and uncertainties not currently
known to us or that we currently do not deem material could also
become important factors that may harm our business. The trading
price of our common stock could decline due to any of these
risks and uncertainties, and you could lose all or part of your
investment.



| |                                                                              
| | -----------------------------------------------------------------------------
| | Our limited operating history makes evaluation of our
    business difficult.

We were originally incorporated in 1997 and began selling
products in September 1997; however, the Company has grown
significantly in size and complexity since its inception. As a
result, we have limited historical financial data upon which to
base planned operating expenses or forecast accurately our
future operating results. Further, our limited operating history
will make it difficult for investors and securities

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| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | We have a history of significant losses. If we do not
    achieve or sustain profitability, our financial condition and
    stock price could suffer.

We have a history of losses and we may continue to incur losses
for the foreseeable future. As of April 2, 2006, our
accumulated deficit was $89.4 million. We have not achieved
profitability for a full fiscal year. If our revenues grow more
slowly than we anticipate, or if our operating expenses exceed
our expectations, we may not be able to achieve full fiscal year
profitability in the near future or at all. Even if we do
achieve full fiscal year profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis
in the future. If we are unable to achieve full fiscal year
profitability within a short period of time, or at all, or if we
are unable to sustain profitability at satisfactory levels, our
financial condition and stock price could be adversely affected.



| |                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we experience seasonal fluctuations in our net
    sales, our quarterly results will fluctuate and our annual
    performance will depend largely on results from one
    quarter.

Our business is highly seasonal, reflecting the general pattern
of peak sales for the retail industry during the holiday
shopping season. Typically, a substantial portion of our net
revenues occur during our third fiscal quarter ending around
December 31. We generally experience lower net revenues
during the first, second and fourth fiscal quarters and, as is
typical in the retail industry, have incurred and may continue
to incur losses in these quarters. The third fiscal quarter
accounted for approximately 46.9% of net revenues in the fiscal
year ended April 2, 2006. We cannot predict with certainty
what percentage of our total net revenues for fiscal year 2007
will be represented by our third fiscal quarter revenues. In
anticipation of increased sales activity during the third fiscal
quarter, we incur significant additional expenses, including
significantly higher inventory and staffing costs. If sales for
the third fiscal quarter do not meet anticipated levels, then
increased expenses may not be offset, which would adversely
affect our financial condition. If we were to experience lower
than expected sales during our third fiscal quarter, for
whatever reason, it would have a disproportionately large
negative impact on our annual operating results and financial
condition for that fiscal year. If our net revenues during our
third fiscal quarter were to fall below projections or the
expectations of securities analysts, our stock price could
decline, perhaps significantly.



| |                                                                                                          
| | ---------------------------------------------------------------------------------------------------------
| | Our operating results are volatile and difficult to
    predict and may adversely affect our stock price.

Our annual and quarterly operating results have fluctuated in
the past and may fluctuate significantly in the future due to a
variety of factors including those discussed in this report,
many of which are outside of our control. Further, because our
business is seasonal, our operating results may vary
significantly from one quarter to the next as part of our normal
business cycle. As a result, we believe that quarterly
comparisons of our operating results are not necessarily
meaningful and that you should not rely on the results of one
quarter as an indication of our future performance. It is likely
that in some future quarter our operating results may fall below
projections or the expectations of securities analysts and
investors. In this event, the trading price of our common stock
could decline, perhaps significantly.



| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | Our computer and communications hardware and software
    systems are vulnerable to damage and interruption, which could
    harm our business.

Our ability to receive and fulfill orders successfully through
our website is critical to our success and largely depends upon
the efficient and uninterrupted operation of our computer and
communications hardware and software systems. Our systems and
operations are vulnerable to damage or interruption from power
outages, computer and telecommunications failures, computer
viruses, security breaches, catastrophic events

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| |                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to offer a broad selection of innovative
    merchandise that consumers find attractive, our revenues could
    decline or fail to reach anticipated levels and our stock price
    could be harmed.

In order to meet our strategic goals, we must successfully
offer, on a continuous basis, a broad selection of appealing
products. These products must satisfy the diverse tastes of our
customers and potential customers for a variety of gift-giving
occasions. To be successful, our product offerings must be
competitively priced, well made, innovative and attractive to a
wide range of consumers whose preferences may change regularly.
We cannot predict with certainty that we will be successful in
offering products that meet these requirements. If our products
become less popular with consumers, our revenues may decline or
fail to meet expected levels or we may decide to offer our
products at lower prices. If a wide range of consumers do not
find our products attractive or if we are required to reduce our
prices, our revenues and earnings may decline or fail to meet
expected levels and our stock price could be affected adversely.



| |                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------
| | Failure to successfully manage or expand our fulfillment
    and distribution operation would have a material adverse effect
    on us.

Our fulfillment and distribution operation is located in leased
facilities in Lockbourne, Ohio. We have limited experience and
have encountered difficulties in the past managing our
fulfillment and distribution operations, and we may encounter
difficulties managing our fulfillment and distribution
operations in the future. If we are unable to manage
successfully our fulfillment and distribution operations and to
meet our customers expectations regarding personalization,
presentation and delivery, our business reputation, operations
and financial condition could be seriously harmed. Further, any
difficulty in managing our fulfillment and distribution
operations could require us to find one or more parties to
provide these services for us. If we are required to engage one
or more service providers, we could incur higher fulfillment
expenses than anticipated or incur additional costs for
balancing merchandise inventories among multiple fulfillment
facilities. Further, we currently anticipate that we will need
to expand and upgrade our fulfillment operations in the future
to accommodate increases in customer orders, increased demand
for personalized products or changes in available technology. If
we fail to successfully manage, expand or make necessary
upgrades to our fulfillment and distribution operations in a
timely and cost-effective manner, it would have a material
adverse effect on our business.

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| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | If we do not manage our inventory levels successfully, our
    operating results may be adversely affected.

We must maintain sufficient inventory levels to operate our
business successfully. Rapidly changing trends in consumer
tastes for gift items expose us to significant inventory risks,
particularly during our third fiscal quarter when inventory
levels are highest due to the holiday shopping season. Consumer
preferences can change between the time we order a product and
the time it is available for sale. We base our product selection
on our projections of consumer tastes and preferences in a
future period, and we cannot guarantee that our projections of
consumer tastes and preferences will be accurate. It is critical
to our success that we accurately predict consumer tastes and
stock our product offerings in appropriate quantities. In the
event that one or more products do not achieve widespread
consumer acceptance, we may be required to take significant
inventory markdowns, which could reduce our net sales and gross
margins. This risk may be greatest in the third fiscal quarter
of each year, after we have significantly increased inventory
levels for the holiday shopping season. In addition, to the
extent that demand for our products increases over time, we may
be forced to increase inventory levels. Any such increase would
require the use of additional working capital and subject us to
additional inventory risks. Further, our failure to stock
sufficient quantities of popular products would likely cause us
to miss revenue opportunities and could cause our customers to
become dissatisfied and look to our competitors for their gift
items, which could also harm our business and reputation. In the
past, some of our popular items were not stocked in quantities
sufficient to meet the demand for such items, which likely led
to missed sales opportunities. If we fail to stock popular
products in sufficient quantities or if we overstock products,
our business, financial condition and operating results would be
affected adversely.



| |                                            
| | -------------------------------------------
| | We may have difficulty in product sourcing.

A significant portion of our products are unique designs
manufactured by third-parties. However, since we do not have
long-term arrangements with any manufacturer, vendor or
distributor that would guarantee the availability of products
from year to year, we do not have a predictable or guaranteed
supply of these products in the future. If we are unable to
provide our customers with continued access to popular products,
our operating results will be harmed.

In addition, we may not receive products from our suppliers in a
timely manner or we may receive products from our suppliers that
do not meet our quality standards. From time to time, we receive
products from suppliers that are of insufficient quality to
provide to our customers. Generally the supplier is able to
quickly rectify the problem, but occasionally we have been
unable to obtain replacement product quickly enough to fulfill
all customer orders for such product in a timely manner,
particularly with respect to items sourced overseas which tend
to have longer delivery lead time requirements. If we do not
receive products from our suppliers in a timely manner or if we
receive products from our suppliers that do not meet our high
quality standards and we are unable to obtain suitable
replacement products in a timely manner, our reputation and our
operating results could be harmed. Further, customers who do not
receive their products in a timely manner may look to our
competitors for their gift items.

Many of our products are sourced overseas. While products
sourced overseas typically have lower costs, our product margins
may be offset by an increase in inbound freight costs. As
security measures around shipping ports increase, these
additional costs may result in higher inbound freight costs.
Increasing competition for overseas production resources,
particularly in China, may result in higher than anticipated
product costs and lower product margins. Furthermore, in recent
years, U.S. companies were subject to port strikes which
delayed the delivery of goods. As we increase our overseas
sourcing, we face the risk of these delays which could seriously
harm our business and results of operations. We cannot predict
whether any of the countries in which our merchandise currently
is manufactured or may be manufactured in the future will be
subject to additional trade restrictions imposed by the U.S. and
other foreign governments, including the likelihood, type or
effect of any such restrictions. Trade restrictions, including
increased tariffs or quotas, embargoes, and customs
restrictions, against items that we offer or intend to offer to
our customers, as well as U.S. or foreign labor strikes,
work stoppages or boycotts, could increase the cost or reduce
the supply of items available to us and adversely affect our
business, financial condition and results of operations. Our
sourcing operations also may be adversely affected by political
and financial instability resulting in the disruption of trade
from exporting countries, significant fluctuation in the value
of the U.S. dollar against foreign currencies,

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| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | Our operating results could suffer if we fail to offer or
    sell sufficient quantities of proprietary products.

In recent periods, the majority of our most popular products
have been designed in-house or were otherwise exclusive to
RedEnvelope. As proprietary products generally carry higher
gross margins than widely available products, any failure to
offer and sell large numbers of proprietary products could
prevent us from achieving our gross margin objectives. If we are
unable for any reason to design or source popular proprietary
products or if we are unable to sell sufficient quantities of
proprietary products during any future period, our operating
results will be adversely affected.



| |                                                                                                 
| | ------------------------------------------------------------------------------------------------
| | Our facilities and systems are vulnerable to natural
    disasters or other catastrophic events.

Our headquarters, customer sales and service center and the
majority of our infrastructure, including computer servers, are
located in California, an area that is susceptible to
earthquakes and other natural disasters. Our distribution
facility, located in Lockbourne, Ohio, houses substantially all
of our product inventory and is the location from which
substantially all of our orders are shipped. A natural disaster
or other catastrophic event, such as an earthquake, fire, flood,
severe storm, break-in, terrorist attack or other comparable
problems could cause interruptions or delays in our business and
loss of inventory and/or data or render us unable to accept and
fulfill customer orders in a timely manner, or at all. Further,
California has in the recent past experienced power outages as a
result of limited electrical power supplies. These outages may
recur in the future and we cannot determine the effect, if any,
that such outages would have on the operation of our business.
In addition, as our inventory and distribution facility is
located in an area that is susceptible to harsh weather, a major
storm, heavy snowfall or other similar event could prevent us
from delivering products in a timely manner. Also, areas in and
around San Diego, California, the site of our customer
sales and service facility, have in the past experienced severe
wildfires. The occurrence of any such wildfires in the future
could destroy, render inoperable or cause the evacuation of our
customer sales and service facility, which could significantly
disrupt our ability to provide satisfactory customer sales and
service. We have no formal disaster recovery plan and our
business interruption insurance may not adequately compensate us
for losses that may occur from any of the foregoing. In the
event that an earthquake, natural disaster or other catastrophic
event were to destroy any part of our facilities or interrupt
our operations for any extended period of time, or if harsh
weather conditions prevent us from delivering products in a
timely manner, our business, financial condition and operating
results could be seriously harmed.



| |                                                                                         
| | ----------------------------------------------------------------------------------------
| | We have grown quickly and if we fail to manage our growth,
    our business will suffer.

We have rapidly and significantly expanded our operations, and
anticipate that further significant expansion, including the
possible acquisition of third-party assets, technologies or
businesses, will be required to address market opportunities and
desired growth in our customer base. Prior expansion has placed,
and any future expansion is expected to continue to place, a
significant strain on our management, operational and financial
resources. Some of our officers and senior management personnel
have no prior senior management experience at public companies.
We have experienced significant turnover among our executive
officers in recent years and our President and Chief Executive
Officer, Chief Financial Officer, and Chief Operating Officer
have only been with the Company for a short period of time. In
addition, we have hired a number of key managerial, technical,
finance, accounting and operations personnel in the recent past.
As a result, key members of our management and employee team are
still in the process of being integrated into our operations.
Additionally, we need to properly implement and maintain our
financial and managerial controls, reporting systems and
procedures, including the increased internal controls and
procedures required by the Sarbanes Oxley Act of 2002. Moreover,
if we are presented with appropriate opportunities, we may in
the future make investments in, or possibly acquire, assets,
technologies or businesses that we believe are complementary to
ours. Any such investment or acquisition may further strain our
financial and managerial controls and reporting systems and
procedures. These difficulties could disrupt or make it more
difficult to plan

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| |                                                                                  
| | ---------------------------------------------------------------------------------
| | We experience intense competition in the rapidly changing
    retail gift market.

We operate in a highly competitive environment. We principally
compete with a variety of department stores, Internet retailers,
specialty retailers and other catalog merchants that offer
products similar to or the same as our products. Increased
competition is likely to result in price reductions, reduced
gross margins and loss of market share, any of which could
seriously harm our net revenues and results of operations. We
expect competition to intensify in the future because current
and new competitors can enter our market with little difficulty
and can launch new websites at a relatively low cost. We
currently or potentially compete with a variety of other
companies, including:



| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | other online retailers, such as Amazon.com and eBay                                                                                                                                                               
|
| |  | major department stores, such as Macys,
    Bloomingdales, Neiman Marcus and their online
    storefronts                                                                                                       
|
| |  | physical and online stores and catalog retailers that sell
    popular gift items such as Pottery Barn, Brookstone, The Sharper
    Image, Tiffanys, Harry & David, J Crew,
    1-800-Flowers and Williams-Sonoma
|
| |  | Internet portals and online service providers and other
    comparison shopping sites, such as AOL, Yahoo! and Google.                                                                                            

Many of our traditional store-based, catalog-based and online
competitors have longer operating histories, larger customer or
user bases, greater brand recognition and significantly greater
resources, particularly financial and marketing resources. Many
of these competitors can devote substantially more resources to
website development and catalog retailing than we can. In
addition, large, well-established and well-financed entities may
establish more robust online sales operations in the future. Our
competitors may be able to secure products from vendors on more
favorable terms, provide popular products to which we do not
have access, fulfill customer orders more efficiently and adopt
more aggressive pricing or inventory availability policies than
we can.

The U.S. retail industry, the specialty retail industry in
particular, and the online commerce sector are highly
competitive, dynamic in nature and have undergone significant
changes over the past several years and will likely continue to
undergo significant changes. Our ability to anticipate and
respond successfully to these changes is critical to our
long-term growth and we cannot assure you that we will
anticipate and respond effectively to changes in the retail
industry and online commerce sectors. If we are unable to
maintain or increase our market share or compete effectively in
the retail gift market, our business, financial condition and
operating results would be affected adversely.



| |                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not successfully expand our website and order
    processing systems or respond to rapid technological changes, we
    could lose customers and our net revenues could decline.

If we fail to upgrade our website in a timely manner to
accommodate higher volumes of traffic, our website performance
could suffer and we may lose customers. In addition, if we fail
to expand the computer systems that we use to process and ship
customer orders and process customer payments, we may not be
able to fulfill customer orders successfully. As a result, we
could lose customers and our net revenues could be reduced.
Further, to remain competitive, we must continue to enhance and
improve the functionality and features of our online store. The
Internet and the online commerce industry are subject to rapid
technological change. If competitors introduce new features and
website enhancements, or if new industry standards and practices
emerge, our existing website and systems may become obsolete or
unattractive. Developing and enhancing our website and other
systems entails significant technical and business risks. We may
use new technologies ineffectively or we may fail to adapt our
website, our transaction processing systems and our computer
network to meet customer requirements or emerging industry
standards. If we are unsuccessful in

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We are currently in the process of implementing new website and
inventory planning software systems. Also, we are in the process
of modifying certain internal processes for the purpose of
improving our productivity and making our operations more cost
efficient. However, we cannot assure you that we will be
successful in these efforts. Possible cost overruns in these
implementation efforts may result in higher than anticipated
capital expenditures and delays in or other problems arising out
of these implementations could lead to customer dissatisfaction.
If we do not successfully implement one or more of these
intended upgrades or modified processes or if we do not achieve
desired efficiencies or cost savings as a result of these
changes or if attempts to enhance our website are unsuccessful
or are not appealing to our customers, our business and
operating results could be harmed, perhaps significantly.



| |                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------
| | Delivery of our merchandise could be delayed or disrupted
    by factors beyond our control, and we could lose customers as a
    result.

As timely gift delivery is essential to our customers
satisfaction, any delay disruption or inaccuracy in order,
fulfillment and delivery for any reason, particularly during the
holiday shopping season, could cause us to lose customers and
negatively affect our business and reputation. In addition, we
rely upon third-party carriers for timely delivery of our
product shipments. As a result, we are subject to carrier
disruptions and delays due to factors that are beyond our
control, including employee strikes and inclement weather.



| |                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------
| | The loss of our senior management or other key personnel
    could harm our current and future operations and
    prospects.

Our performance is substantially dependent on the continued
services and on the performance of our senior management and
other key personnel. Three of our former officers, Edward
Schmults, our former Chief Operating Officer, Kristine Dang, our
former Executive Vice President, Merchandising and Alison May,
our former Chief Executive Officer and President each resigned
from RedEnvelope during fiscal 2006. We have not yet filled the
merchandising position formerly held by Ms. Dang. While we
believe that this will have no material impact on our
operations, we cannot assure you that disruptions occasioned by
their departures or that running our business without certain
key officers will not have an adverse impact on our operations.
Our performance also depends on our ability to retain and
motivate other officers and key employees. We have recently
hired Ken Constable as our President and Chief Executive Officer
and Frank Buettner as our Chief Operating Officer. Polly Boe,
our Chief Financial Officer, has been with the Company for just
over one year. We do not have long-term employment agreements
with these individuals or any of our key personnel. The loss of
the services of Mr. Constable, Ms. Boe,
Mr. Buettner, Mr. Korotzer or Mr. Nordquist or
other key employees for any reason could harm our business,
financial condition and operating results. Our future success
also depends on our ability to identify, attract, hire, train,
retain and motivate other highly skilled technical, managerial,
editorial, merchandising, marketing and customer sales and
service personnel. Competition for such personnel is intense,
particularly in the San Francisco Bay Area, and we cannot
assure you that we will be able to successfully attract,
assimilate or retain sufficiently qualified personnel. Our
failure to attract and retain the necessary technical,
managerial, editorial, merchandising, marketing and customer
sales and service personnel would harm our business, financial
condition and results of operations. Moreover, competition is
particularly intense for highly-qualified senior officers in our
industry, and a variety of factors could make it difficult for
us to attract the right candidates in the near term or at all.
In the event that we cannot hire and retain qualified senior
officers in a timely manner, our business could be adversely
affected.



| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on seasonal and temporary employees during periods
    of peak activity and any failure by such employees to adequately
    perform their jobs could adversely affect our operations.

We depend on temporary and seasonal employees to adequately
staff our fulfillment facility and customer sales and service
facilities during busy periods such as the holiday shopping
season, including individuals responsible for gift
personalization and packaging and responding to consumer
inquiries. Temporary employ-

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| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | Increased merchandise returns and a failure to accurately
    predict merchandise returns could harm our business.

As part of our customer service commitment, we maintain a
merchandise return policy that allows recipients to return
merchandise received from us if they are dissatisfied with those
items (except under certain circumstances, personalized
products). We make allowances for merchandise returns in our
financial statements based on historical return rates and other
factors. We cannot assure you that actual merchandise returns
will not significantly exceed our allowances for returns. In
addition, because our allowances are based on historical return
rates, we cannot assure you that the introduction of new
merchandise in our catalogs, the introduction of new catalogs,
increased sales over the Internet, changes in our merchandise
mix, changes in the habits of our gift item recipients, or other
factors will not cause actual returns to exceed return
allowances, perhaps significantly. Any increase in merchandise
returns that exceed our allowances would affect our business
adversely. Also, returned merchandise that is personalized,
perishable, or damaged likely cannot be re-sold, creating
non-recoverable inventory costs which detrimentally affects our
operating results.



| |                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to successfully manage the costs of our
    catalog operations or our catalogs fail to produce sales at
    satisfactory levels it could adversely affect our
    business.

Our catalog has been an important tool for the acquisition and
retention of customers. We believe that the success of our
catalog as a cost-effective marketing tool depends on the
following factors:



| |   |                                                                                                 
| | - | ------------------------------------------------------------------------------------------------
| |  | effective management of costs associated with the production and
    distribution of our catalog
|
| |  | achievement of adequate response rates to our mailings                                          
|
| |  | displaying a mix of merchandise in our catalog that is
    attractive to our customers          
|
| |  | production of aesthetically appealing catalogs                                                  
|
| |  | timely delivery of catalog mailings to our customers                                            

Catalog production and mailings entail substantial paper,
printing, postage and human labor costs. Increases in the costs
of producing and distributing the RedEnvelope catalog, including
increases in postage rates or paper, photography, or printing
costs, may reduce the margin on sales derived from our catalog.
The U.S. Postal Service is likely to increase its postage
rates in the future and other delivery and overnight courier
services that we utilize to deliver our products also will
likely raise their rates in the future, which could
significantly increase the aggregate cost of mailing our
catalogs. As we incur nearly all of the costs associated with
our catalogs prior to mailing, we are unable to adjust the costs
being incurred in connection with a particular mailing to
reflect the actual performance of the catalog. In addition,
response rates to our mailings and, as a result, revenues
generated by each mailing, are affected by factors such as
constantly changing consumer preferences and our ability to
include a product assortment that satisfies those preferences,
economic conditions, the timing and mix of catalog mailings, the
timely delivery by the postal system of our catalog mailings,
and changes in our merchandise mix, several or all of which may
be outside of our control. In recent periods, we have
experienced slower growth in revenues from our catalog channel
than in our online channels and we expect this trend towards
slower catalog growth to continue. If we were to experience an
increase in the costs associated with producing or delivering
our catalogs or a delay in distributing our catalogs or if our
catalogs fail to produce sales at satisfactory levels, our
operating results would be adversely affected.

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| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | We are dependent on the success of our advertising and
    marketing efforts which are costly and may not achieve desired
    results.

Our revenues depend on our ability to advertise and market our
products effectively through the RedEnvelope catalog and other
advertising and marketing efforts. If we do not successfully
advertise and market our products, our operating results will be
seriously harmed. Increases in the cost of advertising and
marketing, including paper and postage costs, the costs of
online marketing and the costs of complying with applicable
regulations, may limit our ability to advertise and market our
business in a cost-effective manner. In addition, individuals
are increasingly using software programs that block certain
email marketing campaigns, and certain federal and state laws
and regulations may restrict our ability to effectively utilize
email as a marketing tool. If we decrease our advertising, or
marketing activities, if the effectiveness of such activities is
diminished, due to increased costs, restrictions enacted by
regulatory agencies or for any other reason, or if our current
advertising strategy does not yield anticipated results, our
future operating results could be significantly harmed.



| |                                                                                        
| | ---------------------------------------------------------------------------------------
| | If we are unable to provide satisfactory customer service,
    we could lose customers.

Our ability to provide satisfactory levels of customer service
depends, to a large degree, on the efficient and uninterrupted
operation of our call center. Any material disruption or
slowdown in our order processing systems resulting from labor
disputes, telephone or Internet failures, power or service
outages, natural disasters or other events could make it
difficult or impossible to provide adequate customer service and
support. Further, we may be unable to attract and retain
adequate numbers of competent customer service representatives,
which is essential in creating a favorable interactive customer
experience. Due to increased customer service needs during the
holiday shopping season, we hire a relatively large number of
temporary employees during our third fiscal quarter. As a
result, we may have difficulty properly staffing our customer
service operations during our peak sales season. If we are
unable to continually provide adequate staffing for our customer
service operations, our reputation could be seriously harmed.

In addition, we cannot assure you that email and telephone call
volumes will not exceed our present system capacities. If this
occurs, we could experience delays in placing orders, responding
to customer inquiries and addressing customer concerns. Although
we are currently implementing plans to expand its capacity, our
customer sales and service facility currently accommodates
customer sales and service representatives at close to its
capacity during our peak sales period. Because our success
depends in large part on keeping our customers satisfied, any
failure to provide high levels of customer sales and service or
adequately staff our customer sales and service operations would
likely impair our reputation and have an adverse effect on our
business and operating results.



| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | If the protection of our trademarks and proprietary rights
    is inadequate, our brand and reputation could be impaired and we
    could lose customers.

We regard our copyrights, service marks, trademarks, trade
dress, trade secrets and similar intellectual property as
critical to our success. We rely on trademark and copyright law,
trade secret protection and confidentiality agreements with our
employees, consultants, partners, suppliers, and others to
protect our proprietary rights. Nevertheless, the steps we take
to protect our proprietary rights may be inadequate. Further,
effective trademark, service mark, copyright and trade secret
protection may not be available in every country in which we may
sell our products and offer our services or whose residents have
access to our website presently or in the future. In addition,
the relationship between regulations governing domain names and
laws protecting trademarks and similar proprietary rights is
unclear. Therefore, we may be unable to prevent third parties
from acquiring domain names that are similar to, infringe upon
or otherwise decrease the value of our trademarks and other
proprietary rights. If we are unable to protect or preserve the
value of our trademarks, copyrights, trade secrets or other
proprietary rights for any reason, our business would be harmed.

We also rely substantially on technologies that we license from
third parties. These licenses may not continue to be available
to us on commercially reasonable terms, or at all, in the
future. As a result, we may be required to develop or obtain
substitute technology of lower quality or at greater cost, or we
may be prevented

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| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Intellectual property claims against us could be costly
    and could impair our business.

Other parties may assert infringement or unfair competition
claims against us. In the past, we have been subject to claims
or received notices from third parties alleging that our
trademarks or product offerings infringe proprietary rights held
by them. From time to time we also receive claims and become a
defendant in lawsuits alleging that our Internet marketing
program and website operations infringe patents held by third
parties. We cannot predict whether third parties will assert
claims of infringement against us, or whether any past, present
or future claims will prevent us from offering popular products
or operating our business as planned. If we are forced to defend
against third-party infringement claims, whether they are with
or without merit or are determined in our favor, we could face
expensive and time-consuming litigation, which could distract
technical and management personnel, or result in product
shipment delays. If an infringement claim is determined against
us, we may be required to pay monetary damages or ongoing
royalties. Further, as a result of infringement claims either
against us or against those who license technology to us, we may
be required to develop non-infringing intellectual property or
enter into costly royalty or licensing agreements. Such royalty
or licensing agreements, if required, may be unavailable on
terms that are acceptable to us, or at all. If a third-party
successfully asserts an infringement claim against us and we are
required to pay monetary damages or royalties or we are unable
to develop suitable non-infringing alternatives or license the
infringed or similar intellectual property on reasonable terms
on a timely basis, it could significantly harm our business.



| |                                                                                          
| | -----------------------------------------------------------------------------------------
| | We may be subject to litigation proceedings that could
    adversely affect our business.

In addition to the litigation risks mentioned above, it is
possible that, in the course of our business, we could be
subject to legal claims or proceedings involving consumer,
employment, stockholder, contract or other matters. If we are
required to defend against a legal claim or deem it necessary or
advisable to initiate a legal proceeding to protect our rights,
the expense and distraction of such a claim or proceeding,
whether or not resolved in our favor, could adversely affect our
business. Further, if a claim or proceeding were resolved
against us or if we were to settle any such dispute, we could be
required to pay damages or refrain from certain activities,
which could have an adverse impact on our business, financial
condition and operating results.



| |                                         
| | ----------------------------------------
| | We face the risk of inventory shrinkage.

We are subject to the risk of inventory loss and theft. Although
we believe that the levels of inventory shrinkage that we have
suffered in the past are within an acceptable range, we cannot
assure you that incidences of inventory loss and theft will not
increase in the future or that the security measures we have
taken in the past will effectively address the problem of
inventory theft. If we were to suffer higher rates of inventory
shrinkage or incur increased security costs to combat inventory
theft, our financial condition could be affected adversely.



| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | Poor economic conditions may constrain discretionary
    consumer spending on retail products such as ours.

Consumer spending patterns, particularly discretionary spending
for products such as ours, are affected by, among other things,
prevailing economic conditions, stock market volatility, wars,
threats of war, acts of terrorism, wage rates, interest rates,
inflation, taxation, and consumer confidence. General economic,
political and market conditions, such as recessions, may
adversely affect our business results and the market price of
our common stock. Our business and revenues have been, and in
the future could be, negatively affected by poor economic
conditions and any related decline in consumer demand for
discretionary items such as our products. We face uncertainty in
the degree to which poor performance in the retail industry,
decreased consumer confidence or any economic slowdown will
negatively affect demand for our products. We may not be able to
accurately anticipate the magnitude of these effects on future
quarterly results, which could seriously harm our financial
condition. As we do not have large cash reserves, we may not be
able to survive an extended recession or sluggish economy.

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| |                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to meet the borrowing requirements under our
    loan and security agreement, we may be unable to obtain
    necessary short-term financing and if we default on a secured
    loan, material assets of ours could be subject to
    forfeiture.

From time to time, we may experience the need to obtain funding
to meet short-term cash requirements, such as the acquisition of
inventory prior to our holiday selling season. We currently are
party to a loan and security agreement which provides us with a
revolving credit facility for the primary purpose of enabling us
to satisfy any such funding needs. However, as is typical for
agreements of this sort, the loan and security agreement
requires us to meet certain financial conditions as a
prerequisite to obtaining and maintaining loans thereunder and
we can offer no assurances that we will be able to meet such
conditions when a loan is needed or continue to meet such
conditions when a loan is outstanding. If we are unable to meet
the conditions for borrowing under our loan and security
agreement when funds are required, we could be prevented from
purchasing sufficient inventory to meet our revenue and
profitability objectives or from meeting other payment
obligations, which could have a material adverse effect on our
business, financial condition and operating results. Further, if
we were to breach such financial conditions while a loan is
outstanding under the loan and security agreement, it could
constitute a default under that agreement which could require
immediate repayment of amounts owed under the agreement.

Further, our obligations under the loan and security agreement
are secured by substantially all of our tangible and intangible
assets, including intellectual property. If we default under our
loan and security agreement for any reason and are unable to
cure the default pursuant to the terms of that agreement, our
lenders could take possession of any or all of our assets in
which they hold a security interest, including intellectual
property, and dispose of those assets to the extent necessary to
pay off our debts, which could materially harm our business.

The loan and security agreement also contains a covenant that
prohibits us from paying cash dividends to our stockholders.



| |                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need additional financing and may not be able to
    raise additional financing on favorable terms or at all, which
    could increase our costs, limit our ability to grow and dilute
    the ownership interests of existing stockholders.

We anticipate that we may need to raise additional capital in
the future to facilitate long-term expansion, to respond to
competitive pressures or to respond to unanticipated financial
requirements. Since our inception, we have experienced negative
cash flow from operations on a fiscal year basis and may
experience negative cash flow from operations on a fiscal year
basis in the future. We cannot be certain that we will be able
to obtain additional financing on commercially reasonable terms
or at all. If we raise additional funds through the issuance of
equity, equity-related or debt securities, such securities may
have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders would experience
dilution of their ownership interests. We may also be subject to
high interest rates or substantial restrictive covenants.
Further, under the terms of our loan and security agreement, we
are subject to certain contractual limitations with respect to
raising additional capital during the term of that agreement.
Any failure to obtain necessary capital on commercially
reasonable terms could have severe consequences on our business.
Further, an inability to obtain additional financing could
require us to scale back, or fail to address opportunities for
expansion or enhancement of, our operations.



| |                                                                                       
| | --------------------------------------------------------------------------------------
| | We may face product liability claims that are costly and
    create adverse publicity.

If any of the products that we sell causes harm or financial
damages to any of our customers or other individuals, we could
be vulnerable to product liability lawsuits. If we are found
liable under product liability claims, we could be required to
pay substantial monetary damages and our reputation could
suffer. Further, even if we successfully defend ourselves
against this type of claim, we could be forced to spend a
substantial amount of money in litigation expenses, our
management could be required to spend valuable time in the
defense against these claims and the claims could bring adverse
publicity to us, any of which could harm our business.

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| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may incur significant costs or experience delays in
    product availability due to regulations applicable to the sale
    of food products and live plants, which may hurt our
    business.

We currently offer select food items and live plants for sale to
our customers. Applicable federal, state or local regulations
may cause us to incur substantial compliance costs or delay the
availability of those products. In addition, any inquiry or
investigation from a regulatory authority could have a negative
impact on our reputation. The occurrence of any of these events
could adversely affect our financial condition.



| |                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to comply with the laws regulating the sale of
    tobacco products it may have a negative impact on our reputation
    and make us vulnerable to liability claims.

Although we ceased selling tobacco products in June 2006, we
have been required to comply with a range of regulatory
requirements, including age verification in connection with the
sale of our tobacco products. If we have failed to comply with
such regulations or are unable to properly identify the age of
our purchasers, we could face substantial penalties and legal
liability. Any inquiry or investigation from a regulatory
authority could have a negative impact on our reputation and any
liability claims could subject us to fines, mandatory damages or
require us to spend significant time and money in litigation,
any of which could adversely affect our business, financial
condition and operating results.



| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our charter documents, Delaware law and third-party
    contractual restrictions may make an acquisition of us more
    difficult, even if an acquisition would be beneficial to our
    stockholders.

We are a Delaware corporation and the Delaware General
Corporation Law contains certain provisions that may make a
change in control of our company or the removal of incumbent
directors more difficult. In addition, our Amended and Restated
Certificate of Incorporation and Bylaws, contain provisions that
may have the same effect, including the elimination of the
ability of stockholders to call special meetings or vote by
written consent, the elimination of cumulative voting for
directors, and procedures requiring advance notification for
stockholder proposals. The elimination of cumulative voting
substantially reduces the ability of minority stockholders to
obtain representation on the Board of Directors. Also, the Board
of Directors may determine at some point in the future that it
is in the best interests of the Company and its stockholders to
enact additional measures to protect the Company against
unsolicited takeovers or stock accumulation. Such provisions or
the enactment of additional protective measures may discourage
potential acquirers from making a bid for our company, or make
an acquisition of us or a tender offer to our stockholders more
difficult, even if such acquisition or tender offer would be
beneficial to our stockholders, and may reduce any premiums paid
to stockholders for their common stock.

Additionally, under the terms of our loan and security
agreement, we are subject to covenants that could restrict or
place limitations on our ability to be acquired by another
company during the term of the loan and security agreement, even
if such acquisition would be beneficial to our stockholders.



| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | Our success is tied in large part to the continued use of
    the Internet by a large number of consumers.

Our future revenues and profits, if any, substantially depend
upon the continued widespread use of the Internet as an
effective medium of commerce and communication. Factors which
could reduce the widespread use of the Internet include:



| |   |                                                                                              
| | - | ---------------------------------------------------------------------------------------------
| |  | actual or perceived lack of privacy protection                                               
|
| |  | actual or perceived lack of security of credit card information                              
|
| |  | possible disruptions or other damage to the Internet or
    telecommunications infrastructure
|
| |  | increased governmental regulation and taxation                                               
|
| |  | decreased use of personal computers                                                          

Any decrease or less than anticipated growth in Internet usage
could significantly harm our business.

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| |                                                                  
| | -----------------------------------------------------------------
| | Customers may be unwilling to purchase goods on the
    Internet.

As of April 2, 2006, approximately 80% of our customer
orders were placed through our website. Our long-term prospects
therefore depend upon the general publics increasing
willingness to use the Internet as a means to purchase goods.
The failure of the Internet to continue to develop into an
effective and reliable tool for consumer purchases would
seriously damage our future operations. Online commerce is a
relatively new concept, and online purchases may decline or fail
to increase as projected. The future of online commerce is
uncertain, many online commerce companies have ceased operations
in recent years and most existing online commerce companies have
a relatively short operating history. If consumers are unwilling
to use the Internet to purchase retail products, our business
will be significantly harmed.



| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | The security risks of online commerce, including credit
    card fraud, may discourage customers from purchasing goods from
    us.

In order for the online commerce market to develop successfully,
we and other market participants must be able to transmit
confidential information, including credit card information,
securely over public networks. Third parties may have the
technology or know-how to breach the security of customer
transaction data. Any breach could cause consumers to lose
confidence in the security of our website and choose not to
purchase from us. Although we take the security of our systems
very seriously, we cannot guarantee that our security measures
will effectively prohibit others from obtaining improper access
to our information and information of our customers. If a person
is able to circumvent our security measures, he or she could
destroy or steal valuable information or disrupt our operations.
Any security breach could expose us to risks of data loss,
litigation and liability and could seriously disrupt our
operations and harm our reputation, any of which could adversely
affect our business.

We do not carry insurance against the risk of credit card fraud,
so the failure to prevent fraudulent credit card transactions
could reduce our net revenues and gross margin. We may suffer
losses as a result of orders placed with fraudulent credit card
data even though the associated financial institution approved
payment of the orders. Under current credit card practices, we
may be liable for fraudulent credit card transactions because we
do not obtain a cardholders signature. If we are unable to
detect or control credit card fraud, our liability for these
transactions could harm our business, operating results and
financial condition.



| |                                                                      
| | ---------------------------------------------------------------------
| | Existing or future government regulation could harm our
    business.

We are subject to the same federal, state and local laws as
other companies conducting business on the Internet, including
consumer protection laws, user privacy laws and laws and
regulations prohibiting unfair and deceptive trade practices. In
particular, under federal and state financial privacy laws and
regulations, we must provide notice to our customers of our
policies and practices regarding non-public personal information
that we collect and use, including whether we share that
information with third parties, must provide advance notice of
any changes to our privacy policies and must inform our
customers about how they can review and/or correct the
non-public personal information we possess about them. Further,
the growth of online commerce could result in more stringent
consumer protection laws that impose additional compliance
burdens on us. Today there are an increasing number of laws
specifically directed at the conduct of business on the
Internet. Moreover, due to the increasing use of the Internet,
many additional laws and regulations relating to the Internet
are being debated at the state and federal levels. These laws
and regulations could cover issues such as freedom of
expression, pricing, consumer privacy, fraud, quality of
products and services, taxation, advertising, adult-oriented
content, defamation, intellectual property rights, identity
theft and information security. Applicability of existing laws
to the Internet relating to issues such as trademarks,
copyrights and other intellectual property issues, taxation,
libel, obscenity and personal privacy could also harm our
business. For example, United States and international laws
regulate our ability to use customer information and to develop,
buy and sell mailing lists. Many of these laws were adopted
prior to the advent of the Internet, and do not contemplate or
address the unique issues raised by the Internet. Those laws
that do reference the Internet, such as the Digital Millennium
Copyright Act and the recent federal law regulating the
commercial use of e-mail (popularly known as
CAN-SPAM), are only beginning to be interpreted by
the courts and their applicability and reach are therefore
uncertain. The restrictions imposed by, and costs of complying
with,

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In 2003, the California legislature enacted new sections of the
Civil Code that require any company that does business in
California and possesses computerized data, in unencrypted form,
containing certain personal information about California
residents to (i) provide prompt notice to such residents if
that personal information was, or is reasonably believed to have
been, obtained by an unauthorized person such as a computer
hacker and (ii) implement and maintain reasonable security
procedures and practices to protect that information from
unauthorized access, destruction, use, modification or
disclosure. The law defines personal information as an
individuals name together with one or more of that
individuals social security number, drivers license
number, California identification card number, credit card
number, debit card number, or bank account information,
including any necessary passwords or access codes. In 2004, the
California legislature enacted another new section of the Civil
Code that requires any company that owns or licenses personal
information about California residents to implement and maintain
reasonable security procedures and practices to
protect that information from unauthorized access, destruction,
use, modification or disclosure. The law also requires that any
company that discloses personal information about California
residents to a nonaffiliated third party must require by
contract that that party also implement and maintain
reasonable security procedures and practices. As our
customers, including California residents, generally provide
information to us that is covered by this definition of personal
information in connection with their purchases via our website,
our business has been affected by these new laws. As a result,
we will need to ensure that all computerized data containing the
previously-described personal information is sufficiently
encrypted or that we have implemented appropriate measures to
protect the integrity and security of that information and to
notify our California customers of any unauthorized access or
misappropriation. In addition, the code section requiring us to
implement and maintain reasonable security procedures and
practices provides no guidelines as to what may be deemed
reasonable but leaves that determination to future court cases.
This introduces a considerable measure of uncertainty to our
compliance efforts. Such measures will likely increase the costs
of doing business and, if we fail to implement appropriate
safeguards or we fail to detect and provide prompt notice of
unauthorized access as required by the new law, we could be
subject to potential claims for damages and other remedies
available to California residents whose information was
improperly accessed or, under certain circumstances, the State
of California could seek to enjoin our business operations until
appropriate corrective actions have been taken. While we intend
to comply fully with this law, we cannot assure you that we will
be successful in avoiding all potential liability or disruption
of business resulting from this law. If we were required to pay
any significant amount of money in satisfaction of claims under
this law, or any similar law enacted by another jurisdiction, or
if we were forced to cease our business operations for any
length of time as a result of our inability to comply fully with
any such law, our business, operating results and financial
condition could be adversely affected. Further, complying with
the applicable notice requirements in the event of a security
breach could result in significant costs.

Further, federal and state laws place restrictions on email
marketing that could make it more difficult for us to acquire
new customers, or to obtain repeat purchases from prior
customers through inexpensive electronic marketing methods. The
federal CAN-SPAM Act, for example, requires every commercial
e-mail message to include an opt-out mechanism and
requires all senders to comply with their recipients opt
out requests. It also requires senders to label all
commercial e-mail messages as advertisements or solicitations.
These requirements may reduce the effectiveness of our e-mail
marketing activities. If any current or future law requires us
to eliminate or curtail our email marketing efforts, our ability
to obtain new customers and increase revenues could be adversely
affected or we could incur greater marketing costs, either of
which could harm our business. While we intend to comply with
applicable law regarding email marketing, there is no assurance
that we will not incur fines or other liability as a result of
an inadvertent violation of such a law. In addition, because our
website is accessible over the Internet in multiple states and
other countries, we may be subject to their laws and regulations
or may be required to qualify to do business in those locations.
We are qualified to do business only in California and Ohio at
present. Our failure to qualify in a state or country where we
are required to do so could subject us to taxes and penalties
and we could be subject to legal actions and liability in those
jurisdictions. The restrictions or penalties imposed by, and
costs of complying with, these laws and regulations could harm
our business, operating results and financial condition. Our
ability to enforce

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| |                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | Laws or regulations relating to privacy and data
    protection may adversely affect the growth of our Internet
    business or our marketing efforts.

We are subject to increasing regulation relating to privacy and
the use of personal user information. For example, we are
subject to various telemarketing laws that regulate the manner
in which we may solicit future suppliers and customers. Such
regulations, along with increased governmental or private
enforcement, may increase the cost of growing our business.
California has enacted several new laws that require all
commercial website operators that collect personal information
about California residents to adopt and post a privacy policy
that meets certain specified criteria. Any failure to comply
with this new law could subject us to civil penalties,
injunctions, and/or lawsuits. As mentioned above, California
enacted new sections of its Civil Code that require companies
maintaining personal information about California residents to
take reasonable measures to protect against identity theft and
other unauthorized uses of such information and to notify
California residents in the event that such information has been
(or is likely to have been) misappropriated, inappropriately
modified or destroyed. The new laws provide no standards for
satisfactory compliance, so it is impossible to know for certain
what steps the Company needs to take to comply with them.
Compliance could require the Company to implement procedures
that would require it to change the way it does business and
such procedures may be expensive. In addition, several other
states have enacted or proposed legislation that would limit the
uses of personal user information gathered online or require
online services to establish privacy policies. The Federal Trade
Commission has adopted regulations regarding the collection and
use of personal identifying information obtained from children
under 13 years of age. Bills proposed in Congress would
extend online privacy protections to adults. Moreover,
legislation in the United States and existing laws in other
countries require companies to establish procedures to notify
users of privacy and security policies, obtain consent from
users for collection and use of personal information, and/or
provide users with the ability to access, correct and delete
personal information stored by companies. These data protection
regulations and enforcement efforts may restrict our ability to
collect demographic and personal information from users, which
could be costly or harm our marketing efforts. Further, any
violation of privacy or data protection laws and regulations may
subject us to fines, penalties and damages and may otherwise
have a material adverse effect on our business, results of
operations and financial condition.



| |                                                                    
| | -------------------------------------------------------------------
| | We may be subject to liability for the content that we
    publish.

As a publisher of catalogs and online content, we face potential
liability for defamation, negligence, intellectual property
infringement, or other claims based on the information and other
content contained in our catalogs and website. In the past,
parties have brought these types of claims and sometimes
successfully litigated them against online services. If we incur
liability for our catalog or online content, our financial
condition could be affected adversely and our reputation could
suffer.



| |                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our directors, executive officers and significant
    stockholders hold a substantial portion of our stock, which may
    lead to conflicts with other stockholders over corporate
    transactions and other corporate matters.

Our directors, executive officers and current beneficial holders
of 5% or more of our outstanding common stock own a significant
portion of our stock. These stockholders, acting together, are
able to control or influence significantly all matters requiring
stockholder approval, including the election of directors and
significant corporate transactions such as mergers or other
business combinations. This control may delay,

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| |                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------
| | Exploration of strategic opportunities could disrupt our
    operations and cause us to incur significant expenses.

We recently engaged WR Hambrecht & Co as a financial
advisor to assist our management team in exploring strategic
alternatives to maximize stockholder value, including, but not
limited to, the possible sale to, or merger of the business
with, another entity offering strategic opportunities for growth
of our business. However, there can be no assurance that the
exploration of strategic alternatives will result in any
transaction. Further, our engagement of a financial advisor, the
exploration and evaluation of strategic opportunities and the
work involved in any transaction that could result therefrom may
distract our relatively lean management team from their
day-to-day responsibilities, could disrupt the operation of our
business and could cause us to incur significant expenses,
including without limitation payments to advisors and service
providers and expenses associated with holding any required
meeting of stockholders and seeking requisite stockholder
consent in connection with any such potential transaction, any
of which could adversely affect our business, financial
condition and operating results.






|         |                          
|-------- | -------------------------
|Item 1B. | Unresolved Staff Comments

None.






|        |           
|------- | ----------
|Item 2. | Properties

As of April 2, 2006, we leased approximately
28,000 square feet of office space in San Francisco,
California for our corporate headquarters. Also, as of
April 2, 2006, we leased approximately 240,000 square
feet for our fulfillment and distribution center located in
Lockbourne, Ohio and approximately 13,000 square feet for
our customer sales and service center located in San Diego,
California. The lease term for our fulfillment and distribution
center expires in July 2006 and we currently intend to execute a
one year extension to this lease. We believe these facilities
will be sufficient for our needs for at least the next twelve
months, although we can offer no assurances in this regard. For
a discussion of risks related to our facilities, see
Item 1A  Risk Factors.

Our information technology systems are housed in a leased
third-party facility in San Francisco, California which was
moved from Santa Clara, California in July of 2005. Data is
stored in a database that runs on a redundant server and storage
array. We also have standby servers that can provide additional
capacity as necessary. The facility hosting our servers provides
redundant heating, ventilation, air conditioning, power and
Internet connectivity. The redundant data center that we had in
Cincinnati, Ohio is in the process of being eliminated. We
currently plan to establish a failover system at our primary
data center for all of our production systems during the second
quarter of fiscal 2007, although we currently believe that this
will not occur prior to the elimination of the Cincinnati, Ohio
facility. There can be no assurances that we will accomplish
this task in this timeframe or at all. For a discussion of the
risks related to disruption in services at our third-party
facility in San Francisco and Ohio and other
facility-related risks, see Item 1A  Risk
Factors.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

From time to time, the Company is subject to legal proceedings
and claims in the ordinary course of business, including claims
of alleged infringement of trademarks and other intellectual
property rights. The Company is not currently aware of such
legal proceedings or claims that it believes will have,
individually or in the aggregate, a material adverse effect on
its financial position or results of operations.






|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders
during the fourth quarter of the 2006 fiscal year.

23



---



##### Table of Contents






PART II






|        |                                                                                                                     
|------- | --------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities

Our common stock began trading on the Nasdaq National Market
System on September 25, 2003 under the symbol REDE. The
following table sets forth the high and low closing prices for
the periods indicated.

|            |  |      |       |     |  |   |      | 
|----------- |  | ---- | ----- | --- |  | - | ---- | 
|Fiscal 2005 |  | High |       | Low
|            |  |      |       |    
|1st Quarter |  | $    | 10.80 |     |  | $ | 8.17 | 
|           
|           
|           
|           
|2nd Quarter |  | $    | 8.92  |     |  | $ | 6.83 | 
|           
|           
|           
|           
|3rd Quarter |  | $    | 13.70 |     |  | $ | 8.30 | 
|           
|           
|           
|           
|4th Quarter |  | $    | 17.05 |     |  | $ | 7.40 | 

|            |  |      |       |     |  |   |       | 
|----------- |  | ---- | ----- | --- |  | - | ----- | 
|Fiscal 2006 |  | High |       | Low
|            |  |      |       |    
|1st Quarter |  | $    | 10.86 |     |  | $ | 7.69  | 
|           
|           
|           
|           
|2nd Quarter |  | $    | 10.98 |     |  | $ | 9.55  | 
|           
|           
|           
|           
|3rd Quarter |  | $    | 12.98 |     |  | $ | 10.00 | 
|           
|           
|           
|           
|4th Quarter |  | $    | 10.94 |     |  | $ | 9.05  | 

On June 21, 2006, the closing sales price of our common
stock on the Nasdaq National Market System was $9.99.

On September 24, 2003, a Registration Statement on
Form S-1 (Commission File No. 333-106120) relating to
our initial public offering was declared effective by the
Securities and Exchange Commission. The net proceeds to us from
the offering were approximately $29.0 million after
deducting underwriting discounts of $1.8 million. We used
approximately $1.5 million of the net proceeds for fees
related to the offering (excluding banker fees). Since the
initial public offering, we have used approximately
$9.3 million for purchases of property and equipment. We
have used and continue to use the net proceeds to fund our
working capital requirements throughout the year.

Stockholders

The number of stockholders of record as of June 21, 2006
was approximately 267. This number excludes beneficial owners
whose stock is held in nominee or street name.

Dividend Policy

We have never declared nor paid, and do not currently intend to
pay, a cash dividend on our common stock. We currently expect to
retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash
dividends in the foreseeable future. Our loan and security
agreement contains a covenant that prohibits us from paying cash
dividends, see also Item 7 
Managements Discussion and Analysis of Financial Condition
and Results of Operations  Liquidity and Capital
Resources.

Equity Compensation Plan Information

The information required by this Item regarding equity
compensation plans will be set forth in the section with the
caption Equity Compensation Plan Information in our
definitive proxy statement. This information is incorporated
herein by reference.

24



---



##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The table below shows selected financial data for our last
five fiscal years. Our fiscal year is based on a 52 or
53 week year and ends on the Sunday closest to the last day
in March. The following selected financial data should be read
in conjunction with the financial statements and the notes
thereto on Item 8 of Part II, Financial
Statements and Supplementary Data, and the information
contained in Item 7 of Part II,
Managements Discussion and Analysis of Financial
Condition and Results of Operations. Historical results
are not necessarily indicative of future results.

|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |        | 
|----------------------------------------------------------- | -------------------------- | ------------------------------------- | ------- | -------- |  | --------- | ------- | --------- |  | --------- | ------ | ------ |  | - | ------ | ------ |  | - | ------- | ------ | 
|                                                            |                            |                                      
|                                                            |                            | Year Ended                           
|                                                            |                            |                                      
|                                                            |                            | April 2,                              |         | April 3, |  | March 28, |         | March 30, |  | March 31,
|                                                            |                            | 2006                                  |         | 2005     |  | 2004      |         | 2003      |  | 2002     
|                                                            |                            |                                       |         |          |  |           |         |           |  |          
|                                                            |                            |                                      
|                                                            |                            | (In thousands, except per share data)
|                                                           
|                                                           
|                                                           
|                                                           
|Statements of Operations Data:                              |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|                                                           
|                                                           
|                                                           
|                                                           
|Net revenues                                                |                            | $                                     | 113,175 |          |  | $         | 101,418 |           |  | $         | 79,308 |        |  | $ | 70,059 |        |  | $ | 55,778  |       
|                                                           
|                                                           
|                                                           
|                                                           
|Cost of sales                                               |                            |                                       | 55,279  |          |  |           | 48,694  |           |  |           | 39,594 |        |  |   | 36,577 |        |  |   | 31,446  |       
|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|Gross profit                                                |                            |                                       | 57,896  |          |  |           | 52,724  |           |  |           | 39,714 |        |  |   | 33,482 |        |  |   | 24,332  |       
|                                                           
|                                                           
|                                                           
|                                                           
|Operating expenses:                                         |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Fulfillment                |                                       |         | 16,092   |  |           |         | 15,631    |  |           |        | 12,206 |  |   |        | 10,769 |  |   |         | 9,030  | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Marketing                  |                                       |         | 26,284   |  |           |         | 24,425    |  |           |        | 16,680 |  |   |        | 15,280 |  |   |         | 13,411 | 
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | General and administrative |                                       |         | 21,462   |  |           |         | 17,894    |  |           |        | 15,677 |  |   |        | 14,598 |  |   |         | 15,423 | 
|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|Total operating expenses                                    |                            |                                       | 63,838  |          |  |           | 57,950  |           |  |           | 44,563 |        |  |   | 40,647 |        |  |   | 37,864  |       
|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|Loss from operations                                        |                            |                                       | (5,942  | )        |  |           | (5,226  | )         |  |           | (4,849 | )      |  |   | (7,165 | )      |  |   | (13,532 | )     
|                                                           
|                                                           
|                                                           
|                                                           
|Interest income                                             |                            |                                       | 567     |          |  |           | 352     |           |  |           | 170    |        |  |   | 160    |        |  |   | 459     |       
|                                                           
|                                                           
|                                                           
|                                                           
|Interest expense                                            |                            |                                       | (247    | )        |  |           | (279    | )         |  |           | (449   | )      |  |   | (706   | )      |  |   | (1,036  | )     
|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|Net loss                                                    |                            | $                                     | (5,622  | )        |  | $         | (5,153  | )         |  | $         | (5,128 | )      |  | $ | (7,711 | )      |  | $ | (14,109 | )     
|                                                            |                            |                                       |         |          |  |           |         |           |  |           |        |        |  |   |        |        |  |   |         |       
|Net loss per share  basic and diluted                      |                            | $                                     | (0.62   | )        |  | $         | (0.59   | )         |  | $         | (1.16  | )      |  | $ | (24.48 | )      |  | $ | (53.04  | )     
|                                                           
|                                                           
|                                                           
|                                                           
|Weighted average shares outstanding 
    basic and diluted |                            |                                       | 9,007   |          |  |           | 8,749   |           |  |           | 4,422  |        |  |   | 315    |        |  |   | 266     |       

|                                                   |  |                |        |          |  |           |        |           |  |           |        |  |  |   |         |   |  |   |         |  
|-------------------------------------------------- |  | -------------- | ------ | -------- |  | --------- | ------ | --------- |  | --------- | ------ |  |  | - | ------- | - |  | - | ------- | -
|                                                   |  |               
|                                                   |  | As of         
|                                                   |  |               
|                                                   |  | April 2,       |        | April 3, |  | March 28, |        | March 30, |  | March 31,
|                                                   |  | 2006           |        | 2005     |  | 2004      |        | 2003      |  | 2002     
|                                                   |  |                |        |          |  |           |        |           |  |          
|                                                   |  |               
|                                                   |  | (In thousands)
|                                                  
|                                                  
|                                                  
|                                                  
|Balance Sheet Data:                                |  |                |        |          |  |           |        |           |  |           |        |  |  |   |         |   |  |   |         |  
|                                                  
|                                                  
|                                                  
|                                                  
|Cash and cash equivalents                          |  | $              | 3,277  |          |  | $         | 4,807  |           |  | $         | 2,653  |  |  | $ | 4,997   |   |  | $ | 4,910   |  
|                                                  
|                                                  
|                                                  
|                                                  
|Working capital                                    |  |                | 19,435 |          |  |           | 23,038 |           |  |           | 27,638 |  |  |   | 7,179   |   |  |   | 483     |  
|                                                  
|                                                  
|                                                  
|                                                  
|Total assets                                       |  |                | 40,977 |          |  |           | 46,268 |           |  |           | 45,176 |  |  |   | 22,126  |   |  |   | 18,482  |  
|                                                  
|                                                  
|                                                  
|                                                  
|Capital lease obligations                          |  |                | 448    |          |  |           | 869    |           |  |           | 1,412  |  |  |   | 1,775   |   |  |   | 477     |  
|                                                  
|                                                  
|                                                  
|                                                  
|Total indebtedness                                 |  |                |       |          |  |           |       |           |  |           |       |  |  |   | 1,123   |   |  |   | 6,000   |  
|                                                  
|                                                  
|                                                  
|                                                  
|Mandatorily redeemable convertible preferred stock |  |                |       |          |  |           |       |           |  |           |       |  |  |   | 82,556  |   |  |   | 68,410  |  
|                                                  
|                                                  
|                                                  
|                                                  
|Stockholders equity (deficit)                     |  | $              | 25,990 |          |  | $         | 30,034 |           |  | $         | 33,917 |  |  | $ | (71,451 | ) |  | $ | (64,191 | )






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

The following discussion should be read in conjunction with
other sections of this Annual Report on Form 10-K,
including Item 1 of Part 1, Business,
Item 6 of Part II, Selected Financial Data
and Item 8 of Part II, Financial Statements and
Supplementary Data.

25



---



##### Table of Contents



Forward-Looking Statements

This report, together with the documents incorporated herein
by reference, contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act
of 1934, as amended, including without limitation projections
regarding future performance. Such statements are based upon
current expectations and involve risks and uncertainties. Any
statements contained in this report that are not purely
statements of historical fact may be deemed to be
forward-looking statements. Such forward-looking statements may
include but are not limited to statements regarding our future
operations and enhancements, product offerings, business,
financial condition, results of operations and prospects.
Additionally, statements concerning possible changes in
applicable rules or legislation are forward-looking statements.
Words such as expects, anticipates,
intends, plans, believes,
seeks, estimate, may,
might, should, would,
could and similar expressions or variations of such
words are intended to identify forward-looking statements, but
are not the exclusive means of identifying forward-looking
statements in this report. All forward-looking statements in
this report are based upon information available to us as of the
date hereof, and we assume no obligation to revise or update any
such forward-looking statements in order to reflect any event or
circumstance that may arise after the date of this report.
Actual results and the timing of certain events could differ
materially from our current expectations. Factors that could
cause or contribute to such differences include, but are not
limited to, those set forth above in this report under
Item 1A  Risk Factors, and elsewhere
in this report, and those contained from time to time in our
other filings with the SEC. We caution investors that our
business and financial performance are subject to substantial
risks and uncertainties.

Overview

RedEnvelope is a branded online retailer of upscale gifts,
dedicated to helping its predominantly female customers
celebrate and nurture their most important relationships with
unique gifts and unequalled gift-giving experiences. RedEnvelope
offers an extensive and fresh collection of imaginative and
original gifts through our catalog, web store and phone store.
Our in-house design team creates unique proprietary products,
and our merchants source unique products domestically and from
various parts of the world and often commission artists and
vendors to create exclusive gifts. Through our web store,
www.redenvelope.com, customers can search for gifts by
recipient, occasion, gift category and price point. We also
publish our full-color catalog several times a year.

The fiscal year 2006 was a 52-week year and fiscal year 2005 was
a 53-week year. In fiscal year 2006, our net revenues increased
11.6% from $101.4 million in fiscal year 2005 to
$113.2 million. Our net loss for fiscal 2006 was
$5.6 million compared to $5.2 million in the prior
fiscal year. We increased our circulation of catalogs in fiscal
2006 by 19.3% and experienced growth of 10.5% in revenues from
customers who received our catalogs or emails. In fiscal 2006,
online revenue grew 23.6% through our various search and
affiliate sources. Our customer file grew 24.7% in fiscal 2006
to 2.9 million names. The only area of revenue decline was
the revenues from customers that order directly through our web
store without any apparent connection to one of our marketing
programs.

While we achieved revenue growth of 11.6% in fiscal 2006 and
shipped orders grew 10.1%, our average revenue per order only
increased 1.4% reflecting the impact of discounted shipping
offered during the holiday season, as well as a shift in product
mix. This resulted in a slight decrease in gross margins from
52.0% in fiscal year 2005 to 51.2% in fiscal 2006. In fiscal
2007, we will be focusing on improving our shipping margins in
an effort to increase our overall gross margin percent.

Our fulfillment expenses as a percentage of net revenues
decreased from 15.4% in fiscal 2005 to 14.2% in fiscal 2006 due
to improved efficiencies in warehouse management, as well as our
ability to leverage fixed costs across higher net revenues.

Marketing spending focused on increased online marketing and
catalog campaigns, public relations and market research, and
reduced outdoor and print advertising campaigns in fiscal 2006.
This resulted in a slight increase in dollars however marketing
expenses as a percentage of net revenues decreased from 24.1% in
fiscal 2005 to 23.2% in fiscal 2006.

26



---



##### Table of Contents



Our general and administrative expenses increased in dollars and
as a percentage of net revenues primarily due to leadership
transition costs of $1.5 million which were incurred in the
fourth quarter of 2006, as well as increased personnel and
recruiting costs over the prior fiscal year.

For fiscal year 2007, we intend to achieve realistic growth by
focusing our attention on the relationship-building essence of
gift-giving, simplifying our business, and executing with
excellence. We also currently plan to evaluate and test new
off-line and on-line channels for efficient new customer
acquisitions. We currently believe that continued focus in these
areas will allow us to demonstrate and build a stable
operational and financial foundation that will enable us to
achieve a loss for fiscal year 2007 of approximately
$2.0 million to $2.5 million. This projection includes
our current estimate that the adoption of SFAS 123(R) will
result in stock option compensation expenses of approximately
$2.0 million to $2.5 million in fiscal year 2007,
although actual results may differ due to differences and
changes in components of the expense calculation during the
fiscal year. For discussion of the requirements of
SFAS 123(R), see Recently Issued Accounting
Standards below under this Item 7 and Note 1 to
our Financial Statements in Item 8 of this report under the
heading New Accounting Pronouncements.

Although we are committed to our strategic initiatives, there
are inherent risks associated with our business that may present
challenges for us in the future and could prevent us from
achieving our intended results within anticipated timelines or
at all. We have outlined currently identified risks within the
Item 1A  Risk Factors section of
this Annual Report on Form 10-K.

Results of Operations

The following table sets forth our statements of operations data
expressed as a percentage of net revenues for the past three
fiscal years. Our fiscal year is based on a 52 or 53-week year.
The fiscal year ends on the Sunday closest to March 31. The
fiscal year 2005 was a 53-week year and both fiscal year 2006
and 2004 were 52-weeks.

|                               |                            |                                 |       |          |      |           |       |      |      |  |       |      |      | 
|------------------------------ | -------------------------- | ------------------------------- | ----- | -------- | ---- | --------- | ----- | ---- | ---- |  | ----- | ---- | ---- | 
|                               |                            |                                
|                               |                            | Year Ended                     
|                               |                            |                                
|                               |                            | April 2,                        |       | April 3, |      | March 28,
|                               |                            | 2006                            |       | 2005     |      | 2004     
|                               |                            |                                 |       |          |      |          
|                               |                            |                                
|                               |                            | (As percentage of net revenues)
|                              
|                              
|                              
|                              
|Statements of Operation Data:  |                            |                                 |       |          |      |           |       |      |      |  |       |     
|                              
|                              
|                              
|                              
|Net revenues                   |                            |                                 | 100.0 | %        |      |           | 100.0 | %    |      |  | 100.0 | %   
|                              
|                              
|                              
|                              
|                               | Cost of sales              |                                 |       | 48.8     |      |           |       | 48.0 |      |  |       | 49.9 |     
|                               |                            |                                 |       |          |      |           |       |      |      |  |       |     
|Gross profit                   |                            |                                 | 51.2  |          |      |           | 52.0  |      |      |  | 50.1  |     
|                              
|                              
|                              
|                              
|Operating expenses:            |                            |                                 |       |          |      |           |       |      |      |  |       |     
|                              
|                              
|                              
|                              
|                               | Fulfillment                |                                 |       | 14.2     |      |           |       | 15.4 |      |  |       | 15.4 |     
|                              
|                              
|                              
|                              
|                               | Marketing                  |                                 |       | 23.2     |      |           |       | 24.1 |      |  |       | 21.0 |     
|                              
|                              
|                              
|                              
|                               | General and administrative |                                 |       | 19.0     |      |           |       | 17.6 |      |  |       | 19.8 |     
|                               |                            |                                 |       |          |      |           |       |      |      |  |       |     
|                               |                            | Total operating expenses        |       |          | 56.4 |           |       |      | 57.1 |  |       |      | 56.2 | 
|                               |                            |                                 |       |          |      |           |       |      |      |  |       |     
|Loss from operations           |                            |                                 | (5.2  | )        |      |           | (5.1  | )    |      |  | (6.1  | )   
|                              
|                              
|                              
|                              
|Interest income (expense), net |                            |                                 | 0.2   |          |      |           | 0.0   |      |      |  | (0.4  | )   
|                               |                            |                                 |       |          |      |           |       |      |      |  |       |     
|Net (loss)                     |                            |                                 | (5.0  | )%       |      |           | (5.1  | )%   |      |  | (6.5  | )%  
|                               |                            |                                 |       |          |      |           |       |      |      |  |       |     



| |                                                              
| | -------------------------------------------------------------
| | Comparison of Years Ended April 2, 2006 and
    April 3, 2005



| |             
| | ------------
| | Net Revenues

Net revenues are comprised of product sales, shipping revenue
and gift-wrap revenue. Revenues are recorded net of estimated
returns, coupons redeemed by customers, and other discounts. Our
shipping revenue represents the amounts we charge our customers
for delivering the product. Our gift-wrap revenue consists of
amounts we charge our customers for our signature red gift boxes.

27



---



##### Table of Contents



Net revenues were $113.2 million and $101.4 million
for fiscal 2006 and 2005, respectively, representing an 11.6%
increase. The increase was mainly attributable to increased
demand for our products resulting from additional marketing
efforts through our online marketing and catalog campaigns.
Online revenue, through search, portals, and affiliates, grew
23.6% over the prior year. Revenues from customers who received
our catalogs or emails grew 10.5% over the prior year largely as
a result of a 19.3% increase in the circulation of catalogs over
the prior year. We currently expect this trend of slower growth
in our catalog channel to continue. These increases were
slightly offset by a decline in revenues from customers that
order directly through our web store without any apparent
connection to our catalog, online, email, or corporate marketing
activities. Overall, during fiscal 2006, shipped orders grew
10.1% but average revenue per order increased 1.4% reflecting
the impact of discounted shipping offered during the fiscal 2006
holiday season, as well as a shift in product mix. As of
April 2, 2006, we had approximately 2.9 million
customers, representing an increase of approximately 574,000
customers over fiscal 2005.



| |              
| | -------------
| | Cost of Sales

Cost of sales consists of the cost of the product sold, inbound
and outbound freight costs and gift-wrap expense. Handling
costs, which include fulfillment center expenses, are included
in operating expenses  fulfillment.

Cost of sales were $55.3 million and $48.7 million for
fiscal 2006 and 2005, respectively, representing 48.8% and 48.0%
of net revenues, respectively. The 13.6% increase in cost of
sales was mainly attributable to the 11.6% increase in net
revenues. The increase in cost of sales as a percentage of net
revenues was primarily attributable to the discounted shipping
offered during the fiscal 2006 holiday season. Also contributing
to the increase is a $329,000 out-of-period adjustment recorded
in fiscal 2005 to correct an overstatement in an
inventory-related component of our accounts payable liability
which reduced cost of sales for that period.



| |                   
| | ------------------
| | Operating Expenses

Fulfillment. Fulfillment expenses consist of wages and
benefits for employees and seasonal hires working in our
distribution center and customer sales and service facility,
fees incurred to process credit card transactions and certain
fixed costs, such as rent and utilities, incurred at our
distribution center and customer sales and service facility.

Fulfillment expenses were $16.1 million and
$15.6 million for fiscal 2006 and 2005, respectively,
representing 14.2% and 15.4% of net revenues, respectively. The
3.2% increase in dollars reflects an increase in temporary staff
and other variable costs at both the fulfillment center and
customer sales and service center which directly support the
10.1% increase in the number of orders shipped and the 11.6%
increase in net revenues. As a percentage of net revenues, the
decrease was primarily due to improved efficiencies in warehouse
management, as well as our ability to leverage fixed costs
across higher net revenues. During fiscal 2005, we revised our
materials handling processes, implemented new warehouse
management software and effected management changes at the
fulfillment center. We believe that these changes allowed us to
realize these improved efficiencies in fiscal 2006. If we are
unable to continue to improve the efficiency of the fulfillment
process or if we are unable to service the higher order volumes
we anticipate in fiscal year 2007, our business and operating
results could be materially harmed.

Marketing. Marketing expenses consist primarily of online
and catalog programs as well as public relations, other
promotional expenditures, and advertising.

Marketing expenses were $26.3 million and
$24.4 million for fiscal 2006 and 2005, respectively,
representing 23.2% and 24.1% of net revenues, respectively. The
increase in dollars was primarily attributable to additional
spending in our online marketing and catalog campaigns, public
relations and market research, which were partially offset by
reduced spending on our traditional outdoor and print
advertising campaigns. The catalog circulation increased by
19.3% in fiscal year 2006, with the portion of the circulation
focused on prospecting remaining consistent with fiscal year
2005. If we are unsuccessful in generating sufficient revenues
through these marketing vehicles, our operating results will be
adversely affected.

28



---



##### Table of Contents



General and Administrative. General and administrative
expenses consist of wages and benefits for all of our employees,
except for fulfillment and customer sales and service employees.
These expenses also include costs incurred for computer and
communications technology, rent and utilities for our
headquarters, travel, depreciation, and other general corporate
expenditures.

General and administrative expenses were $21.5 million and
$17.9 million for fiscal 2006 and 2005, respectively,
representing 19.0% and 17.6% of net revenues, respectively. The
increase in dollars and as a percentage of net revenues was
primarily due to approximately $1.5 million of leadership
transition costs (including severance, relocation benefits,
recruiting fees and the grant of restricted stock to
Mr. Constable) incurred in the fourth quarter of fiscal
2006, as well as increased personnel and recruiting costs over
the prior fiscal year. In addition, software licenses, software
maintenance and depreciation expense increased due to capital
expenditures made in software equipment and facilities in the
prior year and current year. The regulatory requirements
associated with being a public company, including compliance
with Section 404 of the Sarbanes-Oxley Act of 2002 and
compliance with SFAS No. 123(R), will likely increase
our accounting, consulting and legal expenses. In addition,
compliance with SFAS No. 123(R) will result in
significantly larger stock compensation expense in fiscal 2007.
We anticipate the increase in stock compensation expense to be
approximately $2.0 million to $2.5 million over fiscal
2006. Actual results may differ, however, due to differences and
changes in components of the expense calculation during the 2007
fiscal year.



| |                          
| | -------------------------
| | Other Income and Expenses

Interest Income. Interest income was $0.6 million
and $0.4 million for fiscal years 2006 and 2005,
respectively. The increase is due to a higher return on
short-term investments.

Interest Expense. Interest expense was $0.2 million
and $0.3 million for fiscal years 2006 and 2005,
respectively, primarily representing debt acquisition cost
amortization and interest on capital lease obligations.

Income Taxes. As of April 2, 2006, we had
$81.5 million of net operating loss carryforwards, which
may be impaired or limited in certain circumstances. We are
currently carrying these deferred tax assets, consisting
primarily of net operating loss carryforwards, at a value of
zero because of the uncertainty regarding their realizability.
See Note 5 to the Financial Statements for details
regarding our net operating loss carryforwards, including their
expiration.



| |                                                               
| | --------------------------------------------------------------
| | Comparison of Years Ended April 3, 2005 and
    March 28, 2004



| |             
| | ------------
| | Net Revenues

Net revenues were $101.4 million and $79.3 million for
fiscal 2005 and 2004, respectively, representing a 27.9%
increase. The increase was mainly attributable to increased
demand for our products resulting from additional marketing
efforts through our online marketing, catalog, and advertising
campaigns. Online revenue, through search, portals, and
affiliates, grew 31% over the prior year. Revenues from
customers who received our catalogs grew 36% over the prior year
largely as a result of a 35% increase in the circulation of
catalogs over the prior year. These increases were slightly
offset by a decline in revenues from customers that order
directly through our web store without any apparent connection
to our catalog, online, email, or corporate marketing
activities. Overall, during fiscal 2005, the company experienced
a 23% increase in orders over the prior year and a 5% increase
in revenue per order.

During the third quarter of fiscal 2004, we experienced
unexpectedly high demand for some of our new proprietary
products, which we had bought conservatively. The resulting
inventory deficiencies caused missed revenue opportunities. We
also ran into limitations in our ability to timely fulfill
certain personalized items in our assortment. Rather than
disappoint customers with late deliveries, in some cases we let
customers know that items would not arrive on time, and this led
to order cancellations. These events likely had a negative
effect on our revenues for fiscal 2004.

29



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| |              
| | -------------
| | Cost of Sales

Cost of sales were $48.7 million and $39.6 million for
fiscal 2005 and 2004, respectively, representing 48.0% and 49.9%
of net revenues, respectively. The 23% increase in cost of sales
was mainly attributable to the 27.9% increase in net revenues.
The decrease in cost of sales as a percentage of net revenues
was primarily attributable to higher average product margins
resulting from an increase in overseas product sourcing, which
typically has lower product costs slightly offset by higher
inbound freight and duty costs.

In the fourth quarter of fiscal 2005, the Companys cost of
sales were decreased by a $650,000 out-of-period adjustment to
correct an overstatement in an inventory-related component of
its accounts payable liability. This adjustment included a
decrease to cost of sales of $329,000 associated with fiscal
years prior to fiscal 2005.



| |                   
| | ------------------
| | Operating Expenses

Fulfillment. Fulfillment expenses were $15.6 million
and $12.2 million for fiscal 2005 and 2004, respectively,
representing 15.4% of net revenues in both periods. The 27.9%
increase in dollars was primarily attributable to the 23%
increase in the number of orders and the resulting increase in
labor costs incurred at our distribution center during the third
quarter of fiscal 2005. During the third quarter of fiscal 2004,
delays in the fulfillment process at our fulfillment center
required us to incur additional expenses for more seasonal and
temporary employees and more overtime costs than we had
anticipated. We believe that we made only modest improvements in
efficiencies during fiscal 2005 because we were cautious in
preparing for the holiday season and staffed generously in order
to meet demand with a high level of accuracy. During fiscal
2005, we revised our materials handling processes, implemented
new warehouse management software and effected management
changes at the fulfillment center.

Marketing. Marketing expenses were $24.4 million and
$16.7 million for fiscal 2005 and 2004, respectively,
representing 24.1% and 21.0% of net revenues, respectively. The
increase in dollars and as a percentage of net revenues was
primarily due to the $4.5 million spent on traditional
outdoor and print advertising in the third and fourth quarters
of fiscal year 2005 as well as market research studies conducted
in the first quarter of fiscal year 2005 and the cost of
increased catalog circulation. The catalog circulation increased
by 35% in fiscal year 2005, while the portion of the circulation
focused on prospecting decreased modestly from fiscal year 2004.

General and Administrative. General and administrative
expenses were $17.9 million and $15.7 million for
fiscal 2005 and 2004, respectively, representing 17.6% and 19.8%
of net revenues, respectively. The increase in dollars was
primarily due to training and consulting fees related to our
software and systems implementation projects, higher salaries
due to additional employees hired as well as higher costs
associated with being a public company, including those costs
associated with our 2004 Annual Meeting of Stockholders. The
decrease in expenses as a percentage of net revenues was
primarily due to the allocation of these costs over a higher
revenue base.



| |                          
| | -------------------------
| | Other Income and Expenses

Interest Income. Interest income was $0.4 million
and $0.2 million for fiscal years 2005 and 2004,
respectively. The dollar increase is due to higher average cash
balances and slightly higher interest rates.

Interest Expense. Interest expense was $0.3 million
and $0.4 million for fiscal 2005 and 2004, respectively.
The decrease was attributable to lower amounts of debt
outstanding.



| |                                
| | -------------------------------
| | Liquidity and Capital Resources

Historically, revenues have been seasonal. Revenues have been
higher in the third fiscal quarter, reflecting higher consumer
holiday spending. As a result, our cash balances are seasonal in
nature, with the third fiscal quarter containing both our lowest
level of cash for the year as we build inventory for the holiday
selling season and our highest level upon conclusion of this
season. Throughout the fiscal year, we utilize our cash balances
to build our inventory levels with the most significant use of
working capital occurring

30



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##### Table of Contents





Cash Flows From Operating Activities  Net cash
flows used in operating activities were $7.3 million,
$3.7 million and $0.7 million for fiscal 2006, 2005
and 2004, respectively. Net cash used in operating activities in
fiscal year 2006 resulted primarily from the $5.6 million
net loss and a $5.6 million increase in inventory offset by
$3.1 million in depreciation expense. The increase in
inventory is primarily a result of purchases made at the end of
fiscal 2006 of core items which will be an integral part of our
merchandise assortment through the fiscal 2007 holiday season.
Net cash used in operating activities in fiscal year 2005
resulted primarily from the $5.2 million net loss offset by
the $2.8 million in depreciation expense. There was an
increase in our accrued expenses in fiscal year 2005 in line
with inventory growth associated with the Companys 28%
increase in revenue. Net cash used in operating activities in
fiscal year 2004 resulted primarily from the $5.1 million
net loss offset by the $2.5 million in depreciation expense
and other changes in working capital.

Cash Flows From Investing Activities  Net cash
flows provided by investing activities were $5.2 million
and $5.3 million for fiscal 2006 and 2005, respectively,
and net cash flows used in investing activities was
$27.0 million for fiscal 2004. Net cash provided by
investing activities in fiscal 2006 and 2005 resulted from
maturities of investments, offset somewhat by capital
expenditures for property and equipment. During fiscal 2006, we
spent $2.4 million for various investments in management
systems, our call center and fulfillment center. Tenant
improvements in the call center of approximately
$0.8 million resulted in better visibility and space
utilization of our existing facility as well as an increase in
seasonal workstations, an improved training room and an expanded
phone system and new data network. We are currently planning
various investments in our website and inventory planning
systems, call center and fulfillment center in fiscal 2007 which
may range between approximately $3.0 million to
$3.5 million. We currently believe these investments will
support the needs of our business and customers. Software
implementation projects entail significant technical and
business risks. If we are unsuccessful in implementing these
systems, it may hinder our ability to process and fulfill
customer orders as well as complete critical financial
processing transactions. These capital expenditures may result
in an increase in our depreciation expense. Although we believe
these estimates on expenditures which could adversely affect our
business to be reasonable given the current facts and
circumstances available to us, we can offer no assurance that
the actual amounts expended will not be greater. In fiscal 2004,
uses of cash flow for investing activities were for purchases of
investments as well as capital expenditures for property and
equipment.

Cash Flows From Financing Activities  Net cash
flows provided by financing activities were $0.6 million,
$0.6 million and $25.4 million for fiscal years 2006,
2005, and 2004, respectively. For fiscal years 2006 and 2005,
net cash flows from financing activities consisted of proceeds
from the issuance of stock which were offset by payments on
capital lease obligations. For fiscal year 2004, net cash
provided by financing activities consisted of the net proceeds
from our initial public offering whereby we sold
2.2 million shares of our common stock at $14 per
share and received net proceeds of approximately
$29.0 million (after underwriters discount expenses
of $1.8 million) slightly offset by payments on an existing
line of credit as well as a $1.1 million repayment of a
loan and our initial public offering related expenses of
approximately $1.5 million.

Revolving Credit Facility  As of April 2,
2006 we had in place a revolving credit facility with a lender
under which we had no borrowings. This revolving credit facility
expired on June 13, 2006. On June 26, 2006, we signed
a loan and security agreement with a different lender, which
provides us with a revolving credit facility, the terms of which
are described more fully in Note 6 to the financial
statements contained in this report.

We currently believe that the cash currently on hand and the
cash available to us through our credit facility will be
sufficient to continue operations through at least the next
twelve months. Our assessment is based on historical working
capital needs, operating loss trends, and current business
outlook. Beyond the next twelve months, we intend to utilize the
cash generated from operations and cash available to us through
our credit facility to fund operations and capital expenditures.
Additionally, equity and or additional debt financing

31



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##### Table of Contents







| |                        
| | -----------------------
| | Contractual Obligations

The following table summarizes significant contractual
obligations as of April 2, 2006:

|                     |  |                        |        |           |  |       |       |       |  |         |       |  |  |   |     |  |  |   |   | 
|-------------------- |  | ---------------------- | ------ | --------- |  | ----- | ----- | ----- |  | ------- | ----- |  |  | - | --- |  |  | - | - | 
|                     |  |                       
|                     |  | Payments Due by Period
|                     |  |                       
|                     |  |                        |        | Less Than |  | 1-3   |       | 4-5   |  | After  
|                     |  | Total                  |        | 1 Year    |  | Years |       | Years |  | 5 Years
|                     |  |                        |        |           |  |       |       |       |  |        
|                     |  |                       
|                     |  | (In thousands)        
|                    
|                    
|                    
|                    
|Capital leases       |  | $                      | 487    |           |  | $     | 334   |       |  | $       | 143   |  |  | $ | 10  |  |  | $ |  | 
|                    
|                    
|                    
|                    
|Operating leases     |  |                        | 3,189  |           |  |       | 1,069 |       |  |         | 1,611 |  |  |   | 509 |  |  |   |  | 
|                    
|                    
|                    
|                    
|Purchase obligations |  |                        | 6,902  |           |  |       | 6,869 |       |  |         | 33    |  |  |   |    |  |  |   |  | 
|                     |  |                        |        |           |  |       |       |       |  |         |       |  |  |   |     |  |  |   |   | 
|Total                |  | $                      | 10,578 |           |  | $     | 8,272 |       |  | $       | 1,787 |  |  | $ | 519 |  |  | $ |  | 
|                     |  |                        |        |           |  |       |       |       |  |         |       |  |  |   |     |  |  |   |   | 

Capital Leases  Our $0.5 million of
capital lease obligations consist of equipment used at our
fulfillment center and purchased software. The terms of these
leases extends into our fiscal year 2010. At the end of the
equipment lease term, we have the option to purchase the
equipment for $1.

Operating Leases  At April 2, 2006, we
had operating lease obligations of approximately
$3.2 million. Our operating lease obligations primarily
consist of payments related to properties that we occupy for our
headquarters, customer sales and service center and fulfillment
center. The lease terms expire in December 2009, March 2010 and
July 2006, respectively. We currently intend to exercise our
first option to renew our operating lease for our fulfillment
center which will then expire in July 2007.

Purchase Obligations  Amounts represent
estimated commitments at April 2, 2006 to purchase
inventory and other goods and services in the normal course of
business to meet operational requirements. These obligations are
expected to be paid in future periods as stated in the table.

Other Contractual Arrangements  In our normal
course of business, we are party to a variety of contractual
agreements under which we may be obligated to indemnify the
other party for certain matters. These contracts primarily
relate to our commercial partnerships, supply agreements,
operating leases, license agreements, financial agreements and
various other agreements. Under these contracts, we may provide
certain routine indemnifications relating to representations and
warranties, property damage or personal injury matters. The
terms of these indemnifications range in duration and may not be
explicitly defined. Historically, we have not made significant
payments for these indemnifications. We believe that if we were
to incur a loss in any of these matters, the loss could have a
material adverse effect on our financial condition or results of
operations.

Revolving Credit Facility  As of April 2,
2006 we had in place a revolving credit facility with a lender,
which expired on June 13, 2006. On June 26, 2006, we signed
a loan and security agreement with a different lender, which
provides us with a revolving credit facility, the terms of which
are described more fully in Note 6 to the financial
statements contained in this report.



| |                             
| | ----------------------------
| | Critical Accounting Policies

Our financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses. We base
our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets

32



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Revenue recognition. We derive our revenues from product
sales to consumers and businesses. We generally require payment
by credit card prior to shipment. We recognize revenue on the
date on which we estimate that the product has been received by
the customer, and defer any payments we receive prior to the
date we estimate the customer has received the goods. We use our
third-party freight carrier information as a basis for
determining when delivery has occurred. Revenues are recorded
net of estimated returns, coupons redeemed by customers, and
other discounts. Management judgments and estimates must be made
and used in connection with determining revenue recognized in
any accounting period. In particular, our management must make
estimates of potential future product returns related to current
period revenue. We analyze historical returns, current economic
trends and changes in customer demand and acceptance of our
products when evaluating the adequacy of the sales returns and
other allowances in any accounting period. Actual returns may
differ materially from our estimated reserve. As a result, our
operating results and financial condition could be affected
adversely. The reserve for returns was $0.4 million and
$0.5 million as of April 2, 2006 and April 3,
2005, respectively.

Shipping and Handling Costs. Shipping costs, which
include inbound and outbound freight costs and the cost of
gift-wrap, are included in cost of sales. Handling costs, which
include fulfillment center expenses, are included in operating
expenses  fulfillment. Handling costs included in
operating expenses  fulfillment for the fiscal years
ended April 2, 2006, April 3, 2005 and March 28,
2004 were $6.9 million, $6.7 million and
$4.6 million, respectively. Our gross profit may not be
comparable to other entities, which may allocate all shipping
and handling costs to either cost of sales, resulting in lower
gross profit, or to operating expenses, resulting in higher
gross profit.

Inventory. Inventories are stated at the lower of cost or
market with costs based on the first-in-first-out method. We
estimate a provision for damaged, obsolete, excess and
slow-moving inventory based on inventory aging reports and
specific identification. Specific provisions are recorded in the
event the cost of the inventory exceeds the fair market value.
We also estimate a reserve for expected inventory shrinkage
based on historical shrinkage factors and our current inventory
levels. Actual shrinkage is recorded at year-end based on the
results of our physical inventory count. In addition, we
estimate a reserve for damaged inventory based on historical
realizable values. The inventory reserves increased from
$0.8 million as of April 3, 2005 to $1.4 million
as of April 2, 2006 as a result of higher quantities of
inventory on hand.

Accounting for income taxes. Management judgment is
required in determining our deferred tax assets and liabilities
and any valuation allowance recorded against our net deferred
tax assets. As of April 2, 2006, we had recorded a full
valuation allowance of $30.5 million against our net
deferred tax asset balance due to uncertainties related to our
deferred tax assets as a result of our history of operating
losses as well as other limitations that include, but are not
limited to, a cumulative ownership change of more than 50% over
a three year period. The valuation allowance is based on our
estimates of taxable income by jurisdiction in which we operate
and the period over which our deferred tax assets will be
recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods, we may
need to change the valuation allowance, which could materially
impact our financial position and results of operations.

Catalog Amortization. Prepaid catalog costs consist of
third-party costs including paper, printing, postage, production
and mailing costs for all of our direct response catalogs. Such
costs are capitalized as prepaid catalog costs and are amortized
over their expected period of future benefit which generally
does not exceed three months. Such amortization is based upon
the ratio of actual revenues to the total of actual and
estimated future revenues on an individual catalog basis.
Prepaid catalog costs are evaluated for realizability at each
reporting period. If the carrying amount is in excess of the
estimated probable remaining future net benefit of the catalog,
the excess is expensed in the reporting period.

Valuation of long-lived assets. Long-lived assets held
and used by us are reviewed for impairment whenever events or
changes in circumstances indicate the net book value may not be
recoverable. An impairment loss is recognized if the sum of the
expected future cash flows from use of the asset is less than
the net book value of the asset. The amount of the impairment
loss will generally be measured as the difference

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Stock-based compensation. We account for stock options
granted to employees using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.
Accordingly, no compensation expense has been recognized in the
financial statements for stock options. SFAS No. 123,
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure,
however, requires the disclosure of pro forma net earnings and
earnings per share as if we had adopted the fair value method.
Under SFAS No. 123, the fair value of stock-based
awards to employees is calculated through the use of option
pricing models. These models require subjective assumptions,
including future stock price volatility and expected time to
exercise, which affect the calculated values. Our calculations
are based on a single option valuation approach and forfeitures
are recognized as they occur.



| |                                     
| | ------------------------------------
| | Recently Issued Accounting Standards

In December 2004, the FASB issued SFAS No. 123
(Revised 2004), Share-Based Payment
(SFAS 123(R)). This statement replaces FASB
Statement No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees.
SFAS 123(R) requires all companies to measure compensation
cost for all share-based payments, including stock options, at
fair value. Under the terms of SFAS 123(R), the fair value
of any equity award will be estimated at the grant date and this
fair value will be recognized as compensation cost over the
service period for all awards that are subject to a vesting
period. SFAS 123(R) requires that fair value be estimated
using an option pricing model that takes into account at least
the following items  the exercise price, the expected
term of the option, the current price of the underlying share,
the expected volatility of the price of the underlying share,
the expected dividends on the underlying share and the risk free
rate of interest. Upon adoption of SFAS 123(R),
compensation cost will be recognized for any unvested awards
that were granted prior to the date of adoption using the same
estimate of the grant-date fair value used to determine the pro
forma disclosures under SFAS 123. The statement is
effective for the Company at the beginning of fiscal 2007 and
the adoption of SFAS 123(R) will result in an anticipated
increase in equity compensation expense of approximately
$2.0 million to $2.5 million in fiscal 2007. However,
the actual equity compensation expense may differ, perhaps
materially, due to differences and changes in components of the
calculation during the 2007 fiscal year including, without
limitation, our rate of hiring in fiscal 2007, the amount of
equity awards granted in fiscal 2007, the terms of these awards,
and the fair value of our common stock during fiscal 2007.

In March 2005, the FASB issued FASB Interpretation No.
(FIN) 47, Accounting For Conditional Asset
Retirement Obligations  An Interpretation of FASB
Statement No. 143, which requires an entity to
recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liabilitys fair
value can be reasonably estimated. We adopted the provisions of
FIN 47 as of the end of fiscal 2006. The adoption of this
Interpretation did not have an impact on our consolidated
financial position, results of operations or cash flows.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk

Interest Rate RiskWe currently maintain a portfolio of
fixed and variable investments consisting of cash equivalents,
short-term marketable securities and long-term marketable
securities, which can be affected by changes in market interest
rates. The objective of our investment activities is to preserve
principal, while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, we
invest in highly liquid, investment grade and government debt
securities. Our investments in debt securities are subject to
interest rate risk. According to our investment policy, we may
invest in taxable and tax exempt instruments. In addition, the
policy establishes limits on credit quality, maturity, issuer
and type of instrument. Marketable securities are classified as
available for sale. Marketable securities are
comprised of government securities and corporate bonds. We do
not use derivative financial instruments in our investment
portfolio. (See Note 3 of Notes to Financial Statements)

34



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##### Table of Contents



All highly liquid investments with maturity of three months or
less at the date of purchase are considered to be cash
equivalents. The remaining investments in marketable securities
are considered short-term investments if original maturities
range over three months but less than one year.

The following table lists our cash and cash equivalents and
short-term investments at April 2, 2006:

|                          |  |                |        | 
|------------------------- |  | -------------- | ------ | 
|                          |  |               
|                          |  | (In thousands)
|                          |  |               
|Cash and cash equivalents |  | $              | 3,277  | 
|                         
|                         
|                         
|                         
|Short-term investments    |  |                | 6,762  | 
|                          |  |                |        | 
|Total                     |  | $              | 10,039 | 
|                          |  |                |        | 

If interest rates changed adversely by 100 basis points,
our results from operations and cash flows would not be
materially affected.

Foreign Currency RiskWe purchase a significant amount of
inventory from vendors outside of the U.S. in transactions
that are generally denominated in U.S. dollars. As of
April 2, 2006, any currency risks related to these
transactions were not significant to us. A decline in the
relative value of the U.S. dollar to other foreign
currencies could, however, lead to increased purchasing costs.

35



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|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data

|                                                            |  |      |    | 
|----------------------------------------------------------- |  | ---- | -- | 
|                                                            |  | Page
|                                                            |  |     
|                                                           
|                                                           
|                                                           
|                                                           
|Report of Independent
    Registered Public Accounting Firm |  |      | 37 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Balance Sheets                                              |  |      | 38 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Statements of Operations                                    |  |      | 39 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Statements of
    Stockholders Equity (Deficit)            |  |      | 40 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Statements of Cash Flows                                    |  |      | 41 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Notes to Financial
    Statements                           |  |      | 42 | 

36



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##### Table of Contents






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of



We have audited the accompanying balance sheets of RedEnvelope,
Inc. (the Company) as of April 2, 2006 and
April 3, 2005, and the related statements of operations,
stockholders equity/ (deficit), and cash flows for each of
the three years in the period ended April 2, 2006. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included
consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all
material respects, the financial position of RedEnvelope, Inc.
as of April 2, 2006 and April 3, 2005, and the results
of its operations and its cash flows for each of the three years
in the period ended April 2, 2006, in conformity with
accounting principles generally accepted in the United States of
America.

/s/ DELOITTE & TOUCHE LLP

San Francisco, California



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##### Table of Contents



RedEnvelope, Inc.



BALANCE SHEETS


|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |         |        | 
|---------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ |  | ----- | ------- | ------ | 
|                                         |                                                                                                                                                                                  | April 2,                                   |       | April 3,
|                                         |                                                                                                                                                                                  | 2006                                       |       | 2005    
|                                         |                                                                                                                                                                                  |                                            |       |         
|                                         |                                                                                                                                                                                  |                                           
|                                         |                                                                                                                                                                                  | (In thousands, except                     
|                                         |                                                                                                                                                                                  | share data)                               
|                                        
|                                        
|                                        
|                                        
|ASSETS                                  
|                                        
|                                        
|                                        
|                                        
|Current assets:                          |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                        
|                                        
|                                        
|                                        
|                                         | Cash and cash equivalents                                                                                                                                                        |                                            | $     | 3,277    |        |  | $     | 4,807   |       
|                                        
|                                        
|                                        
|                                        
|                                         | Short-term investments                                                                                                                                                           |                                            |       | 6,762    |        |  |       | 14,356  |       
|                                        
|                                        
|                                        
|                                        
|                                         | Accounts receivable, net                                                                                                                                                         |                                            |       | 1,054    |        |  |       | 992     |       
|                                        
|                                        
|                                        
|                                        
|                                         | Inventory, net                                                                                                                                                                   |                                            |       | 19,690   |        |  |       | 14,048  |       
|                                        
|                                        
|                                        
|                                        
|                                         | Prepaid catalog costs and other current assets                                                                                                                                   |                                            |       | 2,793    |        |  |       | 3,905   |       
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total current assets                       |       |          | 33,576 |  |       |         | 38,108 | 
|                                        
|                                        
|                                        
|                                        
|Property and equipment, net              |                                                                                                                                                                                  |                                            | 7,255 |          |        |  | 7,587 |        
|                                        
|                                        
|                                        
|                                        
|Other assets                             |                                                                                                                                                                                  |                                            | 146   |          |        |  | 573   |        
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total assets                               |       | $        | 40,977 |  |       | $       | 46,268 | 
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                        
|                                        
|                                        
|                                        
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|                                        
|                                        
|                                        
|                                        
|Current liabilities:                     |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                        
|                                        
|                                        
|                                        
|                                         | Accounts payable                                                                                                                                                                 |                                            | $     | 9,759    |        |  | $     | 11,230  |       
|                                        
|                                        
|                                        
|                                        
|                                         | Accrued expenses and other current liabilities                                                                                                                                   |                                            |       | 2,699    |        |  |       | 2,268   |       
|                                        
|                                        
|                                        
|                                        
|                                         | Accrued compensation                                                                                                                                                             |                                            |       | 1,371    |        |  |       | 993     |       
|                                        
|                                        
|                                        
|                                        
|                                         | Capital lease obligations, current                                                                                                                                               |                                            |       | 312      |        |  |       | 579     |       
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total current liabilities                  |       |          | 14,141 |  |       |         | 15,070 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Capital lease obligations, long-term                                                                                                                                             |                                            |       | 136      |        |  |       | 290     |       
|                                        
|                                        
|                                        
|                                        
|                                         | Deferred rent                                                                                                                                                                    |                                            |       | 710      |        |  |       | 874     |       
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total liabilities                          |       | $        | 14,987 |  |       | $       | 16,234 | 
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|Stockholders equity:                    |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                        
|                                        
|                                        
|                                        
|                                         | Common stock, $0.01 par value;
    100 million shares authorized; 9.3 million and
    8.9 million issued and outstanding as of April 2, 2006
    and April 3, 2005, respectively |                                            |       | 94       |        |  |       | 90      |       
|                                        
|                                        
|                                        
|                                        
|                                         | Additional paid-in capital                                                                                                                                                       |                                            |       | 116,739  |        |  |       | 113,831 |       
|                                        
|                                        
|                                        
|                                        
|                                         | Deferred compensation                                                                                                                                                            |                                            |       | (1,372   | )      |  |       | (43     | )     
|                                        
|                                        
|                                        
|                                        
|                                         | Notes receivable from stockholders                                                                                                                                               |                                            |       | (44      | )      |  |       | (44     | )     
|                                        
|                                        
|                                        
|                                        
|                                         | Accumulated deficit                                                                                                                                                              |                                            |       | (89,427  | )      |  |       | (83,805 | )     
|                                        
|                                        
|                                        
|                                        
|                                         | Accumulated other comprehensive income                                                                                                                                           |                                            |       |         |        |  |       | 5       |       
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total stockholders equity                 |       |          | 25,990 |  |       |         | 30,034 | 
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        
|                                         |                                                                                                                                                                                  | Total liabilities and stockholders equity |       | $        | 40,977 |  |       | $       | 46,268 | 
|                                         |                                                                                                                                                                                  |                                            |       |          |        |  |       |        

See accompanying notes to these financial statements.

38



---



##### Table of Contents



RedEnvelope, Inc.



STATEMENTS OF OPERATIONS


|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |        |        | 
|----------------------------------------------------------- | -------------------------- | ------------------------------------- | ------- | -------- | ------ | --------- | ------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                                            |                            |                                      
|                                                            |                            | Fiscal Year Ended                    
|                                                            |                            |                                      
|                                                            |                            | April 2,                              |         | April 3, |        | March 28,
|                                                            |                            | 2006                                  |         | 2005     |        | 2004     
|                                                            |                            |                                       |         |          |        |          
|                                                            |                            |                                      
|                                                            |                            | (In thousands, except per share data)
|                                                           
|                                                           
|                                                           
|                                                           
|Net revenues                                                |                            | $                                     | 113,175 |          |        | $         | 101,418 |        |        | $ | 79,308 |       
|                                                           
|                                                           
|                                                           
|                                                           
|Cost of sales                                               |                            |                                       | 55,279  |          |        |           | 48,694  |        |        |   | 39,594 |       
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|                                                            | Gross profit               |                                       |         | 57,896   |        |           |         | 52,724 |        |   |        | 39,714 |       
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|Operating expenses:                                         |                            |                                       |         |          |        |           |         |        |        |   |        |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Fulfillment                |                                       |         | 16,092   |        |           |         | 15,631 |        |   |        | 12,206 |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Marketing                  |                                       |         | 26,284   |        |           |         | 24,425 |        |   |        | 16,680 |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | General and administrative |                                       |         | 21,462   |        |           |         | 17,894 |        |   |        | 15,677 |       
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|                                                            |                            | Total operating expenses              |         |          | 63,838 |           |         |        | 57,950 |   |        |        | 44,563 | 
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|Loss from operations                                        |                            |                                       | (5,942  | )        |        |           | (5,226  | )      |        |   | (4,849 | )     
|                                                           
|                                                           
|                                                           
|                                                           
|Interest income                                             |                            |                                       | 567     |          |        |           | 352     |        |        |   | 170    |       
|                                                           
|                                                           
|                                                           
|                                                           
|Interest expense                                            |                            |                                       | (247    | )        |        |           | (279    | )      |        |   | (449   | )     
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|Net loss                                                    |                            | $                                     | (5,622  | )        |        | $         | (5,153  | )      |        | $ | (5,128 | )     
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|Net loss per share  basic and diluted                      |                            | $                                     | (0.62   | )        |        | $         | (0.59   | )      |        | $ | (1.16  | )     
|                                                            |                            |                                       |         |          |        |           |         |        |        |   |        |       
|Weighted average shares outstanding 
    basic and diluted |                            |                                       | 9,007   |          |        |           | 8,749   |        |        |   | 4,422  |       

See accompanying notes to these financial statements.

39



---



##### Table of Contents





RedEnvelope, Inc.



STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | --------- | ---- | ------------ |  | ---------- | ---- | -------- |  | ---------- | ----- | ------------ |  | ----------- | -- | ------- |  | - | ------- | - |  | - | ------ | - |  | - | --- | - |  | - | ------- | -
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |            
|                                                                                               |  | Series A  |      |              |  |            |      |          |  | Notes      |       |             
|                                                                                               |  | Preferred |      | Common Stock |  | Additional |      |          |  | Receivable |       |             
|                                                                                               |  |           |      |              |  | Paid-In    |      | Deferred |  | from       |       | Accumulated 
|                                                                                               |  | Shares    |      | Amount       |  | Shares     |      | Amount   |  | Capital    |       | Compensation |  | Stockholder |    | Deficit
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |        
|Balance at March 30, 2003                                                                      |  |           | 627  |              |  |            | 953  |          |  |            | 337   |              |  |             | 4  |         |  |   | 1,322   |   |  |   | (162   | ) |  |   | (44 | ) |  |   | (73,524 | )
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |            | 51    |              |  |             |   |         |  |   | 239     |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of common stock in connection with
    initial public offering, net of issuance costs |  |           |     |              |  |            |     |          |  |            | 2,200 |              |  |             | 22 |         |  |   | 27,419  |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Conversion of preferred stock to common stock in
    connection with initial public offering   |  |           | (627 | )            |  |            | (953 | )        |  |            | 5,956 |              |  |             | 60 |         |  |   | 83,444  |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Stock compensation charge                                                                      |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   | 9       |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Recognition of deferred stock compensation                                                     |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   | 693     |   |  |   | (693   | ) |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   | 260    |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   | (398    | ) |  |   | 398    |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized (loss) on available for sale
    investments                                        |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   | (5,128  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Balance at March 28, 2004                                                                      |  |           |     |              |  |            |     |          |  |            | 8,544 |              |  |             | 86 |         |  |   | 112,728 |   |  |   | (197   | ) |  |   | (44 | ) |  |   | (78,652 | )
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |            | 302   |              |  |             | 4  |         |  |   | 1,123   |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock warrants                                                              |  |           |     |              |  |            |     |          |  |            | 22    |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|ESPP Distribution                                                                              |  |           |      |              |  |            |      |          |  |            | 15    |              |  |             |    |         |  |   | 110     |   |  |   |        |   |  |   |     |   |  |   |         |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized gain/(loss)                                                                         |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of warrants w/loan                                                                    |  |           |     |              |  |            |     |          |  |            | 11    |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   | 24     |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   | (130    | ) |  |   | 130    |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   | (5,153  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Balance at April 3, 2005                                                                       |  |           |     |              |  |            |     |          |  |            | 8,894 |              |  |             | 90 |         |  |   | 113,831 |   |  |   | (43    | ) |  |   | (44 | ) |  |   | (83,805 | )
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |            | 213   |              |  |             | 2  |         |  |   | 1,104   |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|ESPP Distribution                                                                              |  |           |     |              |  |            |     |          |  |            | 18    |              |  |             |   |         |  |   | 137     |   |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized gain/(loss)                                                                         |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |         |   |  |   |       |   |  |   |     |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   | 503    |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   | (26     | ) |  |   | 26     |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of Restricted Stock Award                                                             |  |           |     |              |  |            |     |          |  |            | 200   |              |  |             | 2  |         |  |   | 1,858   |   |  |   | (1,858 | ) |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Repurchase of Restricted Stock                                                                 |  |           |     |              |  |            |     |          |  |            | (18   | )            |  |             |   |         |  |   | (165    | ) |  |   |       |   |  |   |    |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |            |      |              |  |             |   |         |  |   |        |   |  |   |       |   |  |   |    |   |  |   | (5,622  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Balance at April 2, 2006                                                                       |  |           |     |              |  |            |     |          |  |            | 9,307 |              |  | $           | 94 |         |  | $ | 116,739 |   |  | $ | (1,372 | ) |  | $ | (44 | ) |  | $ | (89,427 | )
|                                                                                               |  |           |      |              |  |            |      |          |  |            |       |              |  |             |    |         |  |   |         |   |  |   |        |   |  |   |     |   |  |   |         |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|---------------------------------------------------------------------------------------------- |  | ------------- | -- | ------------- |  | ------------- | ------- | - |  | - | ------ | -
|                                                                                               |  | Accumulated   |    |               |  |              
|                                                                                               |  | Other         |    | Stockholders |  |              
|                                                                                               |  | Comprehensive |    | Equity/       |  | Comprehensive
|                                                                                               |  | Income/(Loss) |    | (Deficit)     |  | Loss         
|                                                                                               |  |               |    |               |  |              
|Balance at March 30, 2003                                                                      |  |               |   |               |  |               | (71,451 | ) |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |               |   |               |  |               | 239     |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of common stock in connection with
    initial public offering, net of issuance costs |  |               |   |               |  |               | 27,441  |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Conversion of preferred stock to common stock in
    connection with initial public offering   |  |               |   |               |  |               | 82,551  |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Stock compensation charge                                                                      |  |               |   |               |  |               | 9       |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Recognition of deferred stock compensation                                                     |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |               |   |               |  |               | 260     |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized (loss) on available for sale
    investments                                        |  |               | (4 | )             |  |               | (4      | ) |  | $ | (4     | )
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |               |   |               |  |               | (5,128  | ) |  |   | (5,128 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Comprehensive loss                                                                             |  |               |    |               |  |               |         |   |  | $ | (5,132 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Balance at March 28, 2004                                                                      |  |               | (4 | )             |  |               | 33,917  |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |               |   |               |  |               | 1,127   |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock warrants                                                              |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|ESPP Distribution                                                                              |  |               |    |               |  |               | 110     |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized gain/(loss)                                                                         |  |               | 9  |               |  |               | 9       |   |  | $ | 9      |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of warrants w/loan                                                                    |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |               |   |               |  |               | 24      |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |               |    |               |  |               | (5,153  | ) |  |   | (5,153 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Comprehensive loss                                                                             |  |               |    |               |  |               |         |   |  | $ | (5,144 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Balance at April 3, 2005                                                                       |  |               | 5  |               |  |               | 30,034  |   |  |   |        |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Exercise of common stock options                                                               |  |               |   |               |  |               | 1,106   |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|ESPP Distribution                                                                              |  |               |   |               |  |               | 137     |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Unrealized gain/(loss)                                                                         |  |               | (5 | )             |  |               | (5      | ) |  | $ | (5     | )
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Amortization of deferred stock compensation                                                    |  |               |   |               |  |               | 503     |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Reversal of deferred compensation                                                              |  |               |   |               |  |               |        |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Issuance of Restricted Stock Award                                                             |  |               |   |               |  |               | 2       |   |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Repurchase of Restricted Stock                                                                 |  |               |   |               |  |               | (165    | ) |  |   |       |  
|                                                                                              
|                                                                                              
|                                                                                              
|                                                                                              
|Net loss                                                                                       |  |               |   |               |  |               | (5,622  | ) |  |   | (5,622 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Comprehensive loss                                                                             |  |               |    |               |  |               |         |   |  | $ | (5,627 | )
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  
|Balance at April 2, 2006                                                                       |  | $             |   |               |  | $             | 25,990  |   |  |   |        |  
|                                                                                               |  |               |    |               |  |               |         |   |  |   |        |  

See accompanying notes to these financial statements.

40



---



##### Table of Contents



RedEnvelope, Inc.



STATEMENTS OF CASH FLOWS


|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |         |         |        |  
|------------------------------------------------------------------------------- | ----------------------------------------------- | --------------------------------------------------------- | ----------------------------------------- | -------- | ------ | --------- | ----- | ------- | ------ | ------ | ------ | ------- | ------- | ------ | -
|                                                                                |                                                 |                                                          
|                                                                                |                                                 | Fiscal Year Ended                                        
|                                                                                |                                                 |                                                          
|                                                                                |                                                 | April 2,                                                  |                                           | April 3, |        | March 28,
|                                                                                |                                                 | 2006                                                      |                                           | 2005     |        | 2004     
|                                                                                |                                                 |                                                           |                                           |          |        |          
|                                                                                |                                                 |                                                          
|                                                                                |                                                 | (In thousands)                                           
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Cash Flows From Operating
    Activities:                                       |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Net loss                                        |                                                           | $                                         | (5,622   | )      |           | $     | (5,153  | )      |        | $      | (5,128  | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Depreciation and amortization                   |                                                           |                                           | 3,119    |        |           |       | 2,820   |        |        |        | 2,523   |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Amortization of deferred stock compensation     |                                                           |                                           | 503      |        |           |       | 24      |        |        |        | 260     |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Loss on disposal of property and equipment      |                                                           |                                           | 217      |        |           |       | 61      |        |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Other non-cash charges                          |                                                           |                                           | (29      | )      |           |       | 312     |        |        |        | 200     |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Changes in operating assets and liabilities:    |                                                           |                                           |          |        |           |       |         |        |        |        |         |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Accounts receivable                                       |                                           |          | (62    | )         |       |         | 63     |        |        |         | (769    | )     
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Inventory                                                 |                                           |          | (5,642 | )         |       |         | (4,439 | )      |        |         | 107     |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Prepaid catalog and other assets                          |                                           |          | 1,401  |           |       |         | (2,073 | )      |        |         | (327    | )     
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Accounts payable                                          |                                           |          | (677   | )         |       |         | 4,505  |        |        |         | 251     |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Accrued expenses and other current liabilities            |                                           |          | (545   | )         |       |         | 142    |        |        |         | 2,142   |       
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                                |                                                 |                                                           | Net cash used in operating activities     |          |        | (7,337    | )     |         |        | (3,738 | )      |         |         | (741   | )
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|Cash Flows From Investing
    Activities:                                       |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Maturities of short-term investments            |                                                           |                                           | 61,664   |        |           |       | 37,459  |        |        |        | 1,000   |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Purchases of short-term investments             |                                                           |                                           | (54,075  | )      |           |       | (27,244 | )      |        |        | (25,571 | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Purchases of property and equipment             |                                                           |                                           | (2,367   | )      |           |       | (4,957  | )      |        |        | (2,441  | )      
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                                |                                                 | Net cash provided by (used in) investing
    activities   |                                           |          | 5,222  |           |       |         | 5,258  |        |        |         | (27,012 | )     
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|Cash Flows From Financing
    Activities:                                       |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Proceeds from issuance of stock                 |                                                           |                                           | 1,245    |        |           |       | 1,233   |        |        |        | 239     |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Principal payments on capital lease obligations |                                                           |                                           | (660     | )      |           |       | (599    | )      |        |        | (733    | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Repayment of loan                               |                                                           |                                           |         |        |           |       |        |        |        |        | (1,123  | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Payment of loan costs and other                 |                                                           |                                           |         |        |           |       |        |        |        |        | (415    | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | Payment of IPO costs                            |                                                           |                                           |         |        |           |       |        |        |        |        | (1,511  | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                | IPO proceeds                                    |                                                           |                                           |         |        |           |       |        |        |        |        | 28,952  |        
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                                |                                                 |                                                           | Net cash provided by financing activities |          |        | 585       |       |         |        | 634    |        |         |         | 25,409 |  
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|Net (decrease) increase in cash and cash
    equivalents                        |                                                 |                                                           | (1,530                                    | )        |        |           | 2,154 |         |        |        | (2,344 | )      
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Cash and cash equivalents at beginning of period                                |                                                 |                                                           | 4,807                                     |          |        |           | 2,653 |         |        |        | 4,997  |        
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|Cash and cash equivalents at end of period                                      |                                                 | $                                                         | 3,277                                     |          |        | $         | 4,807 |         |        | $      | 2,653  |        
|                                                                                |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|Supplemental Cash Flow Information:                                             |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Cash paid for interest                                    |                                           | $        | 109    |           |       | $       | 142    |        |        | $       | 240     |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Cash paid for income taxes                                |                                           |          | 1      |           |       |         | 1      |        |        |         | 1       |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|Supplemental Non cash Investing and Financing
    Activities:                   |                                                 |                                                           |                                           |          |        |           |       |         |        |        |        |        
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Property improvements paid by landlord                    |                                           |          |       |           |       |         | 700    |        |        |         |        |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Equipment acquired through capital lease
    transactions |                                           |          | 311    |           |       |         | 57     |        |        |         | 393     |       
|                                                                               
|                                                                               
|                                                                               
|                                                                               
|                                                                                |                                                 | Conversion of preferred stock to common stock             |                                           | $        |       |           |       | $       |       |        |        | $       | 83,504  |       

See accompanying notes to these financial statements.

41



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##### Table of Contents



RedEnvelope, Inc.



NOTES TO FINANCIAL STATEMENTS




|   |                                           
|-- | ------------------------------------------
|1. | Summary of Significant Accounting Policies

Description of Business  RedEnvelope, Inc.
(the Company) is a branded online retailer of
upscale gifts. The Company offers an extensive and fresh
collection of imaginative, original gifts through its web store
and also publishes full-color catalogs several times during the
year. The Company operates as a single business segment.

Fiscal Year  The Companys fiscal year
ends on the Sunday closest to March 31, based on a
52/53-week year. Fiscal year 2005, which ended on April 3,
2005, was a 53-week period. Fiscal years 2006 and 2004, both
52-week periods, ended on April 2, 2006 and March 28,
2004, respectively.

Use of Estimates  The preparation of financial
statements in conformity with accounting principles generally
accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities as of the date of the financial statements and
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates and
such differences could affect the results of operations reported
in future periods. Our significant accounting policies are set
forth below.

Cash Equivalents  The Company considers all
highly liquid investments purchased with an original or
remaining maturity of three months or less to be cash
equivalents.

Short-term Investments  The Companys
Short-term Investments are considered available-for-sale
securities, as defined by the Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities. The
Companys investment objectives include: preserving
principal, meeting liquidity needs, delivering yields in
relationship to risk tolerance and market conditions, avoiding
inappropriate concentrations of investments, and providing
direct fiduciary control of all cash and investments. Unrealized
short-term investments gains and losses are reflected as a net
amount under the caption of accumulated other comprehensive loss
within the statements of stockholders equity/(deficit).
Realized gains and losses are recorded within the statements of
operations. For the purpose of computing realized gains and
losses, cost is identified on a specific identification basis.

Concentration of Credit Risk  Financial
instruments that potentially subject the Company to a
concentration of credit risk consist of cash, cash equivalents,
marketable debt securities and accounts receivable. Cash and
cash equivalents are deposited with high credit quality
financial institutions. The Companys accounts receivable
are generally derived from credit card purchases from customers
and are typically settled within two to three days.

Allowance for Doubtful Accounts  The Company
reviews the aging of its accounts receivable balances to
specifically identify accounts for uncollectibility.

Inventory. Inventories consist of acquired finished goods
for resale. Inventories are stated at the lower of cost or
market with costs based on the first-in-first-out method. The
Company estimates a provision for damaged, obsolete, excess and
slow-moving inventory based on inventory aging reports and
specific identification. Specific provisions are recorded in the
event the cost of the inventory exceeds the fair market value.
In addition, we estimate a reserve for expected inventory
shrinkage based on historical shrinkage factors and our current
inventory levels. Actual shrinkage is recorded at year-end based
on the results of our physical inventory count. The inventory
reserves were $1.4 million and $0.8 million as of
April 2, 2006 and April 3, 2005, respectively.

Prepaid Catalog Costs  Prepaid catalog costs
consist of third-party costs including paper, printing, postage,
production and mailing costs for all Company direct response
catalogs. These costs are capitalized as prepaid catalog costs
and are amortized over their expected period of future benefit
which generally does not exceed three months. This amortization
is based upon the portion of actual revenues to the total of
actual and estimated future revenues on an individual catalog
basis. Prepaid catalog costs are evaluated for realizability at

42



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

each reporting period. If the carrying amount is in excess of
the estimated probable remaining future net benefit of the
catalog, the excess is expensed in the reporting period. At
April 2, 2006 and April 2, 2005, the Company had
prepaid catalog costs of $1.4 million and
$2.1 million, respectively, recorded as prepaid catalog
costs and other current assets.

Property and Equipment  Property and
equipment, including leasehold improvements, are stated at
historical cost, less accumulated depreciation and amortization.
Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of these
assets, ranging from three to seven years, or, in the case of
leasehold improvements, over the lease period or estimated
useful life, whichever is shorter.

Capitalized Software and Website Development
Costs  The Company capitalizes internally
developed software costs and website development costs in
accordance with the provisions of Statement of Position
(SOP) 98-1, Accounting for Costs of Computer
Software Developed or Obtained for Internal Useand Emerging
Issues Task Force (EITF) No. 00-2,
Accounting for Website Development Costs. Capitalized
costs are amortized on a straight-line basis over the useful
life of the software once it is available for use.

Valuation of Long-Lived Assets  Long-lived
assets held and used by the Company are reviewed for impairment
whenever events or changes in circumstances indicate the net
book value may not be recoverable. An impairment loss is
recognized if the sum of the expected future cash flows from use
of the asset is less than the net book value of the asset. The
amount of the impairment loss will generally be measured as the
difference between net book values of the assets and their
estimated fair values. Our estimate of undiscounted future cash
flows is based upon our experience, historical operations,
estimates of future profitability and economic conditions.

Revenue recognition  The Company derives
revenues from product sales to consumers and businesses.
Generally, payment by credit card is required prior to shipment.
The Companys policy is to recognize revenue on the date on
which the product has been received by the customer, and defer
any payments received prior to the date on which the customer
has received the goods. The Company uses third-party freight
carrier information as a basis for determining when delivery has
occurred.

Revenues are recorded net of estimated returns, coupons redeemed
by customers, and other discounts. The Companys policy is
to record a sales return allowance for anticipated future
returns in the period of sale. The Company generally does not
extend credit to customers, except through third-party credit
cards and for Business Gifts Services corporate customers.

Shipping and Handling Costs  Shipping costs,
which include inbound and outbound freight costs and the cost of
gift wrap, are included in Cost of Sales. Handling costs, which
include fulfillment center expenses, are included in Operating
Expenses  Fulfillment. Handling costs included in
Operating Expenses  Fulfillment for the fiscal years
ended April 2, 2006, April 3, 2005 and March 28,
2004 were $6.9 million, $6.7 million and
$4.6 million, respectively. The Companys gross profit
may not be comparable to other entities, which may allocate all
shipping and handling costs to either cost of sales, resulting
in lower gross profit, or to operating expenses, resulting in
higher gross profit.

Provision for Sales Returns and Allowances 
The provision for sales returns and allowances consists of our
estimates of potential future product returns related to current
period revenue. Management analyzes historical returns, current
economic trends and changes in customer demand and acceptance of
our products when evaluating the adequacy of the sales returns
and allowances. Significant management judgments and estimates
must be made and used in connection with establishing the sales
returns and allowances in any accounting period. Actual returns
may differ materially from our estimated reserve, which could
adversely affect our operating results and financial condition
in future periods.

43



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

A summary of changes in the Reserve for Sales Returns and
Allowances is as follows:

|                                                           |  |                |     |                |  |             |       |            |  |   |        |   |  |   |     | 
|---------------------------------------------------------- |  | -------------- | --- | -------------- |  | ----------- | ----- | ---------- |  | - | ------ | - |  | - | --- | 
|                                                           |  | Balance at     |     | Provision for  |  | Actual      |       | Balance at
|                                                           |  | Beginning      |     | Sales Returns  |  | Returns and |       | End of    
|                                                           |  | of Period      |     | and Allowances |  | Allowances  |       | Period    
|                                                           |  |                |     |                |  |             |       |           
|                                                           |  |               
|                                                           |  | (In thousands)
|                                                          
|                                                          
|                                                          
|                                                          
|Year Ended April 2, 2006 Sales Returns and
    Allowances  |  | $              | 501 |                |  | $           | 4,552 |            |  | $ | (4,623 | ) |  | $ | 430 | 
|                                                          
|                                                          
|                                                          
|                                                          
|Year Ended April 3, 2005 Sales Returns and
    Allowances  |  | $              | 181 |                |  | $           | 4,862 |            |  | $ | (4,542 | ) |  | $ | 501 | 
|                                                          
|                                                          
|                                                          
|                                                          
|Year Ended March 28, 2004 Sales Returns and
    Allowances |  | $              | 140 |                |  | $           | 4,767 |            |  | $ | (4,726 | ) |  | $ | 181 | 

Advertising Expense  The Company expenses the
costs of producing advertisements at the time production occurs
and expenses the cost of communicating advertising in the period
in which the advertising space or airtime is used. Internet
advertising expenses are recognized either in accordance with
the actual number of clicks-through to the RedEnvelope website
or on a straight-line basis over the term of the contract.
Advertising expenses, excluding catalog costs, for fiscal years
2006, 2005, and 2004 were $8.3 million, $10.3 million
and $6.9 million, respectively, and were included in
marketing expenses.

Income Taxes  The Company accounts for income
taxes under the asset and liability approach whereby the
expected future tax consequences of temporary differences
between the book and tax basis of assets and liabilities are
recognized as deferred tax assets and liabilities. A valuation
allowance is established for any deferred tax assets for which
realization is uncertain.

Stock-Based Compensation  The Company accounts
for stock-based employee compensation arrangements in accordance
with provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees(APB No. 25), and complies with the
disclosure provisions of SFAS No. 123, Accounting
for Stock-Based Compensation(SFAS No. 123). Under APB No. 25,
compensation cost is recognized based on the difference, if any,
between the fair market value of the Companys stock on the
date of grant and the amount an employee must pay to acquire the
stock. Equity instruments issued to non-employees are accounted
for in accordance with the provision of SFAS No. 123
and Emerging Issues Task Force Issue No. 96-18.

Had compensation cost for the Companys stock options been
determined based on the fair value of the options at the date of
grant for options granted in fiscal years 2006, 2005 and 2004
consistent with the provisions of SFAS No. 123 the
Companys pro forma net loss would have been as follows:

|                                                                        |                    |                       |        |        |   |      |        |        |   |   |        |        |  
|----------------------------------------------------------------------- | ------------------ | --------------------- | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------ | -
|                                                                        |                    |                      
|                                                                        |                    | Fiscal Year Ended    
|                                                                        |                    |                      
|                                                                        |                    | 2006                  |        | 2005   |   | 2004
|                                                                        |                    |                       |        |        |   |     
|                                                                        |                    |                      
|                                                                        |                    | (In thousands, except
|                                                                        |                    | per share data)      
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Net loss  as reported                                                  |                    | $                     | (5,622 | )      |   | $    | (5,153 | )      |   | $ | (5,128 | )     
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Stock-based employee compensation included in
    reported net loss     |                    |                       | 503    |        |   |      | 24     |        |   |   | 260    |       
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Stock-based compensation expense determined under
    fair value method |                    |                       | (2,141 | )      |   |      | (1,125 | )      |   |   | (716   | )     
|                                                                        |                    |                       |        |        |   |      |        |        |   |   |        |       
|                                                                        | Pro forma net loss |                       | $      | (7,260 | ) |      | $      | (6,254 | ) |   | $      | (5,584 | )
|                                                                        |                    |                       |        |        |   |      |        |        |   |   |        |       
|Basic and diluted earnings per share                                    |                    |                       |        |        |   |      |        |        |   |   |        |       
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | As reported        |                       | $      | (0.62  | ) |      | $      | (0.59  | ) |   | $      | (1.16  | )
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Pro forma          |                       | $      | (0.81  | ) |      | $      | (0.71  | ) |   | $      | (1.26  | )

44



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

In March 2006, the Company granted 200,000 shares of
restricted stock awards to the Chief Executive Officer. The
market price of the underlying common stock on the date of grant
was initially recorded as deferred compensation within the
stockholders equity section of the Companys balance
sheet and subsequently is being amortized over the expected
service period. As of April 2, 2006, $0.5 million of
compensation expense was amortized, representing the 25% vesting
upon issuance, and is included in general and administrative
expense.

Loss Per Share  For all periods presented,
basic net loss per share equals diluted net loss per share
because the effect of stock equivalents (stock options and
warrants outstanding) would have been antidilutive. The weighted
average number of stock options and warrants outstanding
excluded from the calculation for fiscal years 2006, 2005 and
2004 were approximately 1.5 million, 1.4 million and
1.3 million, respectively.

Comprehensive Loss  Comprehensive loss
consists of two components, net loss and other comprehensive
income (loss). Other comprehensive income (loss) refers to
revenue, expenses, gains and losses that under generally
accepted accounting principles are recorded as an element of
stockholders equity but are excluded from net income
(loss).

New Accounting Pronouncements  In December
2004, the FASB issued SFAS No. 123 (Revised 2004),
Share-Based Payment (SFAS 123(R)).
This statement replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation, and
supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees. SFAS 123(R) requires all
companies to measure compensation cost for all share-based
payments, including stock options, at fair value. Under the
terms of SFAS 123(R), the fair value of any equity award
will be estimated at the grant date and this fair value will be
recognized as compensation cost over the service period for all
awards that are subject to a vesting period. SFAS 123(R)
requires that fair value be estimated using an option pricing
model that takes into account at least the following
items  the exercise price, the expected term of the
option, the current price of the underlying share, the expected
volatility of the price of the underlying share, the expected
dividends on the underlying share and the risk free rate of
interest. Upon adoption of SFAS 123(R), compensation cost
will be recognized for any unvested awards that were granted
prior to the date of adoption using the same estimate of the
grant-date fair value used to determine the pro forma
disclosures under SFAS 123. The statement is effective for
the Company at the beginning of fiscal 2007 and the adoption of
SFAS 123(R) will result in an anticipated increase in
equity compensation expense of approximately $2.0 million
to $2.5 million in fiscal 2007. However, actual results may
differ due to differences and changes in components of the
calculation during the 2007 fiscal year.

In March 2005, the FASB issued FASB Interpretation No.
(FIN) 47, Accounting For Conditional Asset
Retirement Obligations  An Interpretation of FASB
Statement No. 143, which requires an entity to
recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liabilitys fair
value can be reasonably estimated. We adopted the provisions of
FIN 47 as of the end of fiscal 2006. The adoption of this
Interpretation did not have an impact on our consolidated
financial position, results of operations or cash flows.

Reclassifications  Certain items in the prior
years financial statements have been reclassified to
conform to the fiscal 2006 presentation.



|   |                        
|-- | -----------------------
|2. | Initial Public Offering

On September 30, 2003, the Company completed its initial
public offering, whereby the Company sold 2.2 million
shares of common stock at $14 per share and received
proceeds of approximately $29.0 million (after
underwriters discounts of $1.8 million). Total
related offering expenses were approximately $1.5 million
(excluding underwriters discounts).

On September 30, 2003, the Companys outstanding
Preferred Stock was automatically converted into approximately
6.0 million shares of common stock. Each share of
Series A and B preferred stock outstanding

45



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

was converted into common stock on a one-for-one exchange ratio
of common for preferred. Each share of Series C, D, E, and
F preferred stock outstanding was converted into common stock on
an exchange ratio of one share of preferred for approximately
1.58, 1.80, 1.27 and 0.99 shares of common, respectively.



|   |            
|-- | -----------
|3. | Investments

All of the Companys investments are considered
available-for-sale. Available-for-sale investments are recorded
at fair market value, with unrealized gains or losses included
in accumulated other comprehensive income. As of April 2,
2006, there were no unrealized gains or losses related to
available-for-sale short-term investments. Short-term
investments are comprised of auction rate securities with an
auction maturity of three months or less but an underlying
long-term maturity and government securities and corporate bonds
both with original maturities beyond three months but less than
one year.

Available-for-sale investments at April 2, 2006 and
April 3, 2005 were as follows (in thousands):

|                                     |       |                |       |          |  |   |        |        | 
|------------------------------------ | ----- | -------------- | ----- | -------- |  | - | ------ | ------ | 
|                                     |       | April 2,       |       | April 3,
|                                     |       | 2006           |       | 2005    
|                                     |       |                |       |         
|                                     |       |               
|                                     |       | (In thousands)
|                                    
|                                    
|                                    
|                                    
|Auction rate securities (short-term) |       | $              | 6,762 |          |  | $ | 11,361 |       
|                                    
|                                    
|                                    
|                                    
|Government securities (short-term)   |       |                |      |          |  |   | 1,257  |       
|                                    
|                                    
|                                    
|                                    
|Corporate bonds (short-term)         |       |                |      |          |  |   | 1,738  |       
|                                     |       |                |       |          |  |   |        |       
|                                     | Total |                | $     | 6,762    |  |   | $      | 14,356 | 
|                                     |       |                |       |          |  |   |        |       

There were no realized gains or losses the fiscal year ended
April 2, 2006, April 3, 2005 and March 28, 2004.



|   |                       
|-- | ----------------------
|4. | Property and Equipment

Property and equipment consists of the following (estimated
useful life):

|                                                          |       |                |         |          |  |   |         |        | 
|--------------------------------------------------------- | ----- | -------------- | ------- | -------- |  | - | ------- | ------ | 
|                                                          |       | April 2,       |         | April 3,
|                                                          |       | 2006           |         | 2005    
|                                                          |       |                |         |         
|                                                          |       |               
|                                                          |       | (In thousands)
|                                                         
|                                                         
|                                                         
|                                                         
|Machinery and computer equipment (3 years)                |       | $              | 8,126   |          |  | $ | 7,678   |       
|                                                         
|                                                         
|                                                         
|                                                         
|Software (3 years)                                        |       |                | 5,368   |          |  |   | 5,505   |       
|                                                         
|                                                         
|                                                         
|                                                         
|Fulfillment equipment under capital lease
    (3-7 years) |       |                | 1,615   |          |  |   | 1,917   |       
|                                                         
|                                                         
|                                                         
|                                                         
|Furniture and fixtures (5 years)                          |       |                | 611     |          |  |   | 460     |       
|                                                         
|                                                         
|                                                         
|                                                         
|Leasehold improvements (3-5 years)                        |       |                | 2,375   |          |  |   | 1,593   |       
|                                                         
|                                                         
|                                                         
|                                                         
|Software development in progress                          |       |                | 2,180   |          |  |   | 692     |       
|                                                          |       |                |         |          |  |   |         |       
|                                                          | Total |                |         | 20,275   |  |   |         | 17,845 | 
|                                                         
|                                                         
|                                                         
|                                                         
|Less: accumulated depreciation and amortization           |       |                | (13,020 | )        |  |   | (10,258 | )     
|                                                          |       |                |         |          |  |   |         |       
|                                                          | Total |                | $       | 7,255    |  |   | $       | 7,587  | 
|                                                          |       |                |         |          |  |   |         |       

The cost of property and equipment under capital leases was
$2.4 million and $2.8 million at April 2, 2006
and April 3, 2005, respectively. Accumulated depreciation
for assets under capital leases was $2.0 million and
$1.8 million, at April 2, 2006 and April 3, 2005,
respectively.

46



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)



|   |             
|-- | ------------
|5. | Income Taxes

The Company has not recorded a tax benefit in any period
presented due to losses incurred and uncertainty of realizing
the net operating loss carryforwards. A reconciliation of the
statutory federal income tax rate with the Companys
effective income tax rate is as follows:

|                       |  |      |       |      |  |      |       |    |  |  |       |   
|---------------------- |  | ---- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                       |  | 2006 |       | 2005 |  | 2004
|                       |  |      |       |      |  |     
|Federal statutory rate |  |      | (34.0 | )%   |  |      | (34.0 | )% |  |  | (34.0 | )%
|                      
|                      
|                      
|                      
|State taxes and other  |  |      | (4.8  | )    |  |      | (4.8  | )  |  |  | (6.0  | ) 
|                      
|                      
|                      
|                      
|Valuation allowance    |  |      | 38.8  |      |  |      | 38.8  |    |  |  | 40.0  |   
|                       |  |      |       |      |  |      |       |    |  |  |       |   
|                       |  |      | 0.0   | %    |  |      | 0.0   | %  |  |  | 0.0   | % 
|                       |  |      |       |      |  |      |       |    |  |  |       |   

Deferred tax assets are summarized as follows:

|                          |                                  |                |         |          |        |   |         |        |        | 
|------------------------- | -------------------------------- | -------------- | ------- | -------- | ------ | - | ------- | ------ | ------ | 
|                          |                                  | April 2,       |         | April 3,
|                          |                                  | 2006           |         | 2005    
|                          |                                  |                |         |         
|                          |                                  |               
|                          |                                  | (In thousands)
|                         
|                         
|                         
|                         
|Deferred tax assets:      |                                  |                |         |          |        |   |         |       
|                         
|                         
|                         
|                         
|                          | Net operating loss carryforwards |                | $       | 29,224   |        |   | $       | 27,588 |       
|                         
|                         
|                         
|                         
|                          | Allowance and accruals           |                |         | 1,233    |        |   |         | 2,033  |       
|                          |                                  |                |         |          |        |   |         |       
|                          |                                  | Total          |         |          | 30,457 |   |         |        | 29,621 | 
|                         
|                         
|                         
|                         
|Less: valuation allowance |                                  |                | (30,457 | )        |        |   | (29,621 | )     
|                          |                                  |                |         |          |        |   |         |       
|Net deferred tax assets   |                                  | $              |        |          |        | $ |        |       
|                          |                                  |                |         |          |        |   |         |       

The Company believes that, based on a number of factors, the
available objective evidence creates sufficient uncertainty
regarding the realizability of the deferred tax assets such that
a full valuation allowance has been recorded. A valuation
allowance is provided when it is more likely than not that some
portion of the deferred tax asset will not be realized. The
Company established a 100% valuation allowance at April 2,
2006 and April 3, 2005 due to the uncertainty of realizing
future tax benefits from its net operating loss carryforward and
other deferred tax assets.

At April 2, 2006, the Company had net operating loss
carryforwards for federal income tax purposes of approximately
$81.5 million that are due to expire beginning in fiscal
year 2020 through fiscal 2027. State net operating loss
carryforwards are approximately $31.5 million that are due
to expire beginning in fiscal year 2009 through fiscal 2017.
Under the Internal Revenue Code of 1986, as amended, the amounts
of and benefits from net operating loss and tax carryforwards
may be impaired or limited in certain circumstances. Events
which could cause limitations in the amount of net operating
losses that the Company may utilize in any one year include, but
are not limited to, a cumulative ownership change of more than
50%, as defined, over a three year period. The Companys
preferred stock issuances created an ownership change of more
than 50% which caused annual limitations in the amount of net
operating losses that arose prior to such ownership change that
the Company may utilize for both federal and state purposes. In
addition, the Companys initial public offering and/or
changes in its stock ownership since its initial public offering
may have caused further ownership changes and may result in
additional annual limitations in the amount of its federal and
state net operating losses that the Company may utilize.



|   |                       
|-- | ----------------------
|6. | Borrowing Arrangements

As of April 2, 2006, the Company had a line of credit from
a lender which expired on June 13, 2006. As of
April 2, 2006 and April 3, 2005, the Company did not
have any outstanding borrowings under this credit facility.

47



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

On June 26, 2006, the Company signed a loan and security
agreement with a lender that provides for a senior secured
revolving credit facility in an amount equal to the lesser of
$12.5 million or an amount determined under a borrowing
base formula. The borrowing base formula is determined by the
sum of the appraised net retail liquidation value of eligible
inventory, eligible credit card accounts receivable, less
applicable reserves. As of June 26, 2006, the borrowing
base reflected an availability of $7.0 million. Interest
will accrue on amounts borrowed under the credit facility at the
prime lending rate or a LIBOR rate plus an applicable margin.
The loan and security agreement provides for certain events of
default, sets forth affirmative and negative covenants,
including without limitation certain financial covenants, to
which the Company must adhere and expires in June 2010.
Borrowings will be secured by a first priority interest in all
of the Companys assets, tangible and intangible, and
proceeds realized from the sale or other disposition thereof.



|   |                              
|-- | -----------------------------
|7. | Commitments and Contingencies

Leases  The Company leases office space and
equipment under noncancelable operating and capital leases with
various expiration dates through 2010. Rent expense for the
fiscal years 2006, 2005 and 2004 was approximately
$1.6 million, $1.8 million, and $1.9 million,
respectively. Future minimum lease payments under noncancelable
operating and capital leases as of April 2, 2006 are as
follows:

|                                                   |  |                |      |           |  |   |       | 
|-------------------------------------------------- |  | -------------- | ---- | --------- |  | - | ----- | 
|                                                   |  | Capital        |      | Operating
|                                                   |  | Leases         |      | Leases   
|                                                   |  |                |      |          
|                                                   |  |               
|                                                   |  | (In thousands)
|                                                  
|                                                  
|                                                  
|                                                  
|Fiscal 2007                                        |  | $              | 334  |           |  | $ | 1,069 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Fiscal 2008                                        |  |                | 126  |           |  |   | 802   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Fiscal 2009                                        |  |                | 17   |           |  |   | 809   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Fiscal 2010                                        |  |                | 10   |           |  |   | 509   | 
|                                                   |  |                |      |           |  |   |       | 
|Total minimum lease payments                       |  |                | 487  |           |  | $ | 3,189 | 
|                                                   |  |                |      |           |  |   |       | 
|Less: Amount representing interest                 |  |                | (39  | )         |  |   |       | 
|                                                   |  |                |      |           |  |   |       | 
|Present value of capital lease obligations         |  |                | 448  |           |  |   |       | 
|                                                  
|                                                  
|                                                  
|                                                  
|Less: Current portion of capital lease obligations |  |                | (312 | )         |  |   |       | 
|                                                   |  |                |      |           |  |   |       | 
|Long-term portion of capital lease obligations     |  | $              | 136  |           |  |   |       | 
|                                                   |  |                |      |           |  |   |       | 

Legal Proceedings  From time to time, the
Company is subject to legal proceedings and claims in the
ordinary course of business, including claims of alleged
infringement of trademarks and other intellectual property
rights. The Company is not currently aware of such legal
proceedings or claims that it believes will have, individually
or in the aggregate, a material adverse effect on its financial
statements.



|   |                               
|-- | ------------------------------
|8. | Stock Option and Benefit Plans

In March 2006, the Company granted 200,000 shares of
restricted stock awards to the Chief Executive Officer. The
market price of the underlying common stock on the date of grant
was initially recorded as deferred compensation within the
stockholders equity section of the Companys balance
sheet and subsequently is being amortized over the expected
service period. As of April 2, 2006, $0.5 million of
compensation expense was amortized, representing the 25% vesting
upon issuance, and is included in general and administrative
expense.

In March 2006, the Company granted 125,000 common stock options
to the Chief Operating Officer. The exercise price of these
options is $9.56, and they will vest 25% six months after the
commencement of his employment with the Company and as to 1/42
of the balance of the shares each month thereafter for so long
as he is employed by the Company.

48



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Neither of these grants were made pursuant to one of the
Companys equity compensation plans.



| |                       
| | ----------------------
| | 1999 Stock Option Plan

The Company maintains a stock option plan, as amended (the
1999 Plan), which authorizes the Board of Directors
to grant incentive stock options and nonstatutory stock options
to employees, directors and consultants. The maximum aggregate
number of shares that may be granted under the Plan is
2,228,864 shares of common stock, plus an annual increase
on the first day of each of the Companys fiscal years
beginning in each of 2005 through 2009 equal to the lesser of
(a) 426,985 shares, (b) 4% of the shares
outstanding on the last day of the immediately preceding fiscal
year, or (c) such lesser number of shares as the Board
shall determine; provided however that the maximum number of
shares that may be added in any year pursuant to this sentence
shall not result in the 1999 Plans having available for
issuance an aggregate number of shares that exceeds 4% of the
fully diluted shares of outstanding common stock as of the last
day of the immediately preceding fiscal year.

Generally, options vest 25% on the first anniversary of the date
of grant and thereafter become exercisable in equal monthly
installments over the remaining 36 months. Options are
exercisable for a term of ten years after the date of grant. No
options will be granted to any individual who owns more than 10%
of total combined voting power of all classes of stock.

The 1999 Plan also provides for early exercise of options prior
to vesting. Any unvested shares purchased are subject to
repurchase by the Company upon occurrence of certain events or
conditions, such as employment termination, at the original
purchase price. As of April 2, 2006 and April 3, 2005,
there were no shares outstanding subject to repurchase rights
under the 1999 Plan.

In fiscal year 2004, the Company granted approximately
0.3 million options to employees at an exercise price that
was less than the fair market value of the Companys stock
on the date of grant. The Company recorded $0.7 million of
deferred compensation related to these option grants, which is
included as a separate component of stockholders equity,
and is being amortized over the vesting period of the awards.
The Company recorded compensation expense of $10,000, $24,000
and $130,000 in fiscal years 2006, 2005 and 2004, respectively
which is included in general and administrative expenses in the
statements of operations.



| |                            
| | ---------------------------
| | Directors Stock Option Plan

The Directors Stock Option Plan is intended to be a formula
award plan providing for the grant of nonstatutory stock options
to non-employee members of our Board of Directors. Initial
option grants vest 25% on each of the first four anniversaries
of the date of grant, and annual option grants vest 100% on the
first anniversary of the grant date.

The Company registered 449,615 shares of $0.01 par
value common stock for the Directors Stock Option Plan.

49



---



##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The following table summarizes activity under the Companys
stock option plans:

|                                            |  |                                          |       |             |  |                  |       |   |  |   |       | 
|------------------------------------------- |  | ---------------------------------------- | ----- | ----------- |  | ---------------- | ----- | - |  | - | ----- | 
|                                            |  | Shares                                   |       |             |  | Weighted Average
|                                            |  | Available                                |       | Options     |  | Exercise Price  
|                                            |  | for Grant                                |       | Outstanding |  | per Share       
|                                            |  |                                          |       |             |  |                 
|                                            |  |                                         
|                                            |  | (In thousands, except per share amounts)
|                                           
|                                           
|                                           
|                                           
|Balance at March 30, 2003                   |  |                                          | 291   |             |  |                  | 794   |   |  | $ | 3.16  | 
|                                           
|                                           
|                                           
|                                           
|Additional shares authorized                |  |                                          | 1,217 |             |  |                  |      |   |  |   |      | 
|                                           
|                                           
|                                           
|                                           
|Granted (weighted average fair value $5.02) |  |                                          | (681  | )           |  |                  | 681   |   |  |   | 8.50  | 
|                                           
|                                           
|                                           
|                                           
|Cancelled                                   |  |                                          | 235   |             |  |                  | (235  | ) |  |   | 3.47  | 
|                                           
|                                           
|                                           
|                                           
|Exercised                                   |  |                                          |      |             |  |                  | (51   | ) |  |   | 4.27  | 
|                                            |  |                                          |       |             |  |                  |       |   |  |   |       | 
|Balance at March 28, 2004                   |  |                                          | 1,062 |             |  |                  | 1,189 |   |  |   | 6.09  | 
|                                           
|                                           
|                                           
|                                           
|Granted (weighted average fair value $4.28) |  |                                          | (683  | )           |  |                  | 683   |   |  |   | 8.96  | 
|                                           
|                                           
|                                           
|                                           
|Cancelled                                   |  |                                          | 182   |             |  |                  | (182  | ) |  |   | 9.25  | 
|                                           
|                                           
|                                           
|                                           
|Exercised                                   |  |                                          |      |             |  |                  | (302  | ) |  |   | 3.79  | 
|                                            |  |                                          |       |             |  |                  |       |   |  |   |       | 
|Balance at April 3, 2005                    |  |                                          | 561   |             |  |                  | 1,388 |   |  |   | 7.47  | 
|                                           
|                                           
|                                           
|                                           
|Additional shares authorized                |  |                                          | 181   |             |  |                  |      |   |  |   |      | 
|                                           
|                                           
|                                           
|                                           
|Granted (weighted average fair value $4.91) |  |                                          | (634  | )           |  |                  | 634   |   |  |   | 10.11 | 
|                                           
|                                           
|                                           
|                                           
|Cancelled                                   |  |                                          | 424   |             |  |                  | (424  | ) |  |   | 9.15  | 
|                                           
|                                           
|                                           
|                                           
|Exercised                                   |  |                                          |      |             |  |                  | (213  | ) |  |   | 5.18  | 
|                                            |  |                                          |       |             |  |                  |       |   |  |   |       | 
|Balance at April 2, 2006                    |  |                                          | 532   |             |  |                  | 1,385 |   |  | $ | 8.65  | 
|                                            |  |                                          |       |             |  |                  |       |   |  |   |       | 
|Exercisable, March 28, 2004                 |  |                                          |       |             |  |                  | 552   |   |  | $ | 3.53  | 
|                                           
|                                           
|                                           
|                                           
|Exercisable, April 3, 2005                  |  |                                          |       |             |  |                  | 496   |   |  | $ | 5.00  | 
|                                           
|                                           
|                                           
|                                           
|Exercisable, April 2, 2006                  |  |                                          |       |             |  |                  | 623   |   |  | $ | 6.30  | 

The following table summarizes information about stock options
outstanding under the Companys stock option plans at
April 2, 2006:

|                |  |                                     |       |                     |  |                  |     |             |  |                  |       |  |  |  |     |  |  |   |       | 
|--------------- |  | ----------------------------------- | ----- | ------------------- |  | ---------------- | --- | ----------- |  | ---------------- | ----- |  |  |  | --- |  |  | - | ----- | 
|                |  |                                     |       |                    
|                |  | Options Outstanding                 |       | Options Exercisable
|                |  |                                     |       |                    
|                |  |                                     |       | Weighted Average    |  |                  |     |            
|                |  |                                     |       | Remaining           |  | Weighted Average |     |             |  | Weighted Average
|                |  | Number                              |       | Contractual Life    |  | Exercise Price   |     | Number      |  | Exercise Price  
|Exercise Price  |  | Outstanding                         |       | (Years)             |  | per Share        |     | Outstanding |  | per Share       
|                |  |                                     |       |                     |  |                  |     |             |  |                 
|                |  |                                    
|                |  | (In 000s except per share amounts)
|               
|               
|               
|               
|$ 0.59 - $ 5.86 |  |                                     | 305   |                     |  |                  | 6.2 |             |  | $                | 1.86  |  |  |  | 303 |  |  | $ | 1.86  | 
|               
|               
|               
|               
|$ 5.87 - $ 9.95 |  |                                     | 368   |                     |  |                  | 8.9 |             |  |                  | 8.86  |  |  |  | 150 |  |  |   | 8.33  | 
|               
|               
|               
|               
|$ 9.96 - $11.96 |  |                                     | 480   |                     |  |                  | 9.1 |             |  |                  | 10.36 |  |  |  | 60  |  |  |   | 10.58 | 
|               
|               
|               
|               
|$11.97 - $16.85 |  |                                     | 232   |                     |  |                  | 7.4 |             |  |                  | 13.63 |  |  |  | 110 |  |  |   | 13.48 | 
|                |  |                                     |       |                     |  |                  |     |             |  |                  |       |  |  |  |     |  |  |   |       | 
|                |  |                                     | 1,385 |                     |  |                  | 8.2 |             |  | $                | 8.65  |  |  |  | 623 |  |  | $ | 6.30  | 
|                |  |                                     |       |                     |  |                  |     |             |  |                  |       |  |  |  |     |  |  |   |       | 

50



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The pro-forma disclosures required by SFAS No. 123 are
included in Note 1. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes Method
with the following weighted-average assumptions:

|                        |  |            |      |      |  |      |      |   |  |  |      |  
|----------------------- |  | ---------- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                        |  |           
|                        |  | Year Ended
|                        |  |           
|                        |  | 2006       |      | 2005 |  | 2004
|                        |  |            |      |      |  |     
|Expected dividend rate  |  |            | 0.0  | %    |  |      | 0.0  | % |  |  | 0.0  | %
|                       
|                       
|                       
|                       
|Expected volatility     |  |            | 59.3 | %    |  |      | 68.2 | % |  |  | 60.0 | %
|                       
|                       
|                       
|                       
|Risk-free interest rate |  |            | 4.2  | %    |  |      | 3.6  | % |  |  | 3.3  | %
|                       
|                       
|                       
|                       
|Expected lives (yrs.)   |  |            | 4.0  |      |  |      | 4.0  |   |  |  | 4.0  |  

Employee Stock Purchase Plan
(ESPP)  The ESPP allows employees to
purchase common stock at a discount to market price through
payroll deductions. The plan is structured through a series of
consecutive six-month offering periods. Except for the first
offering period, these offering periods generally start on the
first trading day on or after May 1st and
November 1st of each year and end, respectively, on
the last trading day of the next October and April. The Company
registered 401,366 shares $0.01 par value common stock
for the ESPP. During fiscal year 2006, the Company issued
17,917 shares stock under the ESPP.

401(k) Savings Plan  The Company sponsors a
401(k) Savings Plan which allows all employees to make salary
deferral contributions ranging from 1% to 15% of their eligible
earnings. The Company can make discretionary matching
contributions to the Plan. During fiscal years 2006, 2005, and
2004, the Company contributed $95,000, $98,000 and $66,000,
respectively, to the Plan.



|   |                           
|-- | --------------------------
|9. | Related Party Transactions

Notes receivable from stockholders represent amounts owed to the
Company from the exercise of stock options. These full recourse
notes are collateralized by common stock and bear interest at a
rate of 5.74% per annum. Interest and principal is due on
July 20, 2007. At April 2, 2006 and April 3,
2005, notes receivable were approximately $44,000.



|    |                                            
|--- | -------------------------------------------
|10. | Quarterly Financial Information (Unaudited)

The quarterly financial information presented below reflects all
adjustments, which, in the opinion of management, are of a
normal and recurring nature necessary to present fairly the
results of operations for the periods presented.

|                                |  |                                          |        |            |  |            |        |          |  |       |        |  |  |   |        |   |  |   |         |  
|------------------------------- |  | ---------------------------------------- | ------ | ---------- |  | ---------- | ------ | -------- |  | ----- | ------ |  |  | - | ------ | - |  | - | ------- | -
|                                |  |                                         
|                                |  | Fiscal 2006 Quarter Ended               
|                                |  |                                         
|                                |  | July 3,                                  |        | October 2, |  | January 1, |        | April 2, |  | 2006 
|                                |  | 2005                                     |        | 2005       |  | 2006       |        | 2006     |  | Total
|                                |  |                                          |        |            |  |            |        |          |  |      
|                                |  |                                         
|                                |  | (In thousands, except per share amounts)
|                               
|                               
|                               
|                               
|Net revenues                    |  | $                                        | 24,978 |            |  | $          | 13,124 |          |  | $     | 53,029 |  |  | $ | 22,044 |   |  | $ | 113,175 |  
|                               
|                               
|                               
|                               
|Gross profit                    |  |                                          | 13,249 |            |  |            | 6,178  |          |  |       | 27,721 |  |  |   | 10,748 |   |  |   | 57,896  |  
|                               
|                               
|                               
|                               
|Operating income (loss)         |  |                                          | (1,830 | )          |  |            | (3,562 | )        |  |       | 4,075  |  |  |   | (4,625 | ) |  |   | (5,942  | )
|                               
|                               
|                               
|                               
|Net income (loss)               |  |                                          | (1,752 | )          |  |            | (3,489 | )        |  |       | 4,102  |  |  |   | (4,483 | ) |  |   | (5,622  | )
|                               
|                               
|                               
|                               
|Basic income (loss) per share   |  | $                                        | (0.20  | )          |  | $          | (0.39  | )        |  | $     | 0.45   |  |  | $ | (0.49  | ) |  | $ | (0.62   | )
|                               
|                               
|                               
|                               
|Diluted income (loss) per share |  | $                                        | (0.20  | )          |  | $          | (0.39  | )        |  | $     | 0.43   |  |  | $ | (0.49  | ) |  | $ | (0.62   | )

51



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

|                                |  |                                          |        |               |  |              |        |          |  |       |        |  |  |   |        |   |  |   |         |  
|------------------------------- |  | ---------------------------------------- | ------ | ------------- |  | ------------ | ------ | -------- |  | ----- | ------ |  |  | - | ------ | - |  | - | ------- | -
|                                |  |                                         
|                                |  | Fiscal 2005 Quarter Ended               
|                                |  |                                         
|                                |  | June 27,                                 |        | September 26, |  | December 26, |        | April 3, |  | 2005 
|                                |  | 2004                                     |        | 2004          |  | 2004         |        | 2005(1)  |  | Total
|                                |  |                                          |        |               |  |              |        |          |  |      
|                                |  |                                         
|                                |  | (In thousands, except per share amounts)
|                               
|                               
|                               
|                               
|Net revenues                    |  | $                                        | 21,131 |               |  | $            | 10,574 |          |  | $     | 47,514 |  |  | $ | 22,199 |   |  | $ | 101,418 |  
|                               
|                               
|                               
|                               
|Gross profit                    |  |                                          | 11,232 |               |  |              | 5,131  |          |  |       | 25,838 |  |  |   | 10,523 |   |  |   | 52,724  |  
|                               
|                               
|                               
|                               
|Operating income (loss)         |  |                                          | (948   | )             |  |              | (3,904 | )        |  |       | 2,775  |  |  |   | (3,149 | ) |  |   | (5,226  | )
|                               
|                               
|                               
|                               
|Net income (loss)               |  |                                          | (952   | )             |  |              | (3,887 | )        |  |       | 2,768  |  |  |   | (3,082 | ) |  |   | (5,153  | )
|                               
|                               
|                               
|                               
|Basic income (loss) per share   |  | $                                        | (0.11  | )             |  | $            | (0.44  | )        |  | $     | 0.32   |  |  | $ | (0.35  | ) |  | $ | (0.59   | )
|                               
|                               
|                               
|                               
|Diluted income (loss) per share |  | $                                        | (0.11  | )             |  | $            | (0.44  | )        |  | $     | 0.30   |  |  | $ | (0.35  | ) |  | $ | (0.59   | )



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The fourth quarter of 2005 includes an adjustment of $650,000
    relating to prior periods, which decreased cost of goods sold,
    increased gross profit and decreased net loss. The out-of-period
    adjustment includes $321,000 associated with prior fiscal
    quarters in 2005 and $329,000 associated with prior years. The
    effect of the adjustment to any prior period would not be
    material.

52



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##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Disclosure Controls and Procedures  The
Company evaluated the design and operation of its disclosure
controls and procedures to determine whether they are effective
in ensuring that the disclosure of required information is
timely and made in accordance with the Exchange Act and the
rules and forms of the Securities and Exchange Commission. This
evaluation was made under the supervision and with the
participation of management, including the Companys
principal executive officer and principal financial officer as
of the end of the period being reported on in this Annual Report
on Form 10-K. The Company continues to formalize and
document procedures already in place. Maintenance of disclosure
controls and procedures is an ongoing process and controls and
procedures may change over time. The Company also has
established a Disclosure Committee, which consists of certain
members of the Companys senior management. Based on this
evaluation, our chief executive officer and our chief financial
officer have concluded that our disclosure controls and
procedures, as defined at Exchange Act Rules 13a-15(e) and
15d-15(e), are effective to ensure that information required to
be disclosed by the Company in reports that it files under the
Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange
Commission rules and forms. During the last fiscal quarter,
there have not been any changes to the Companys internal
control over financial reporting that have materially affected,
or that are reasonably likely to materially affect, the
Companys internal control over financial reporting.






|         |                  
|-------- | -----------------
|Item 9B. | Other Information

On February 10, 2006, the Board of Directors approved an
amendment to the employment agreements of Polly Boe,
Gary Korotzer and Chris Nordquist that will provide them
with the following benefits: 12 months of salary in the
event of termination of employment following a change in control
of the Company and 6 months of salary in the event of a
voluntary resignation following a change in control of the
Company. The Board of Directors also approved an amendment to
the employment agreement of Frank Buettner that will provide him
with 6 months of salary in the event of a voluntary
resignation following a change in control of the Company.
Mr. Buettner is already provided with certain change of
control benefits in the event of the termination of his
employment following a change in control of the Company under
his existing agreement.

On January 31, 2006, the Board of Directors approved, and
the Company has paid, additional compensation to Polly Boe, the
Companys Chief Financial Officer, and Christopher
Nordquist, the Companys General Counsel, for assuming
additional management responsibilities associated with the
recent leadership transitions. For the period beginning
January 15, 2006 until March 12, 2006, Ms. Boe
was paid additional cash compensation at a rate of
$12,500 per month, and for the period beginning
January 15, 2006 through the present time,
Mr. Nordquist is being paid additional cash compensation at
a rate of $5,000 per month. Mr. Nordquist will continue to
receive this additional monthly amount until such time as the
Compensation Committee determines that Mr. Nordquist is no
longer assuming such additional management responsibilities. On
such date, the Board of Directors also approved an increase to
the base salaries to Polly Boe, Gary Korotzer and Chris
Nordquist such that they each currently receive an annual base
salary of $285,000.

On January 23, 2006, Kristine Dang, the Companys
Executive Vice President, Merchandising, resigned from the
Company. In connection with her resignation, the Company and
Ms. Dang entered into a Separation Agreement and General
Release, dated January 23, 2006, which provides that the
Company will pay Ms. Dang severance in the amount of
$137,500 and for six months of her health care coverage in
exchange for a general release of all claims against the
Company. The foregoing description of the Separation Agreement
and General Release is qualified in its entirety by reference to
the provisions of the Separation and General Release attached as
Exhibit 10.56 to this annual report of Form 10-K.

On May 11, 2006, the Compensation Committee of the Board of
Directors approved a modification of Mr. Buettners
employment offer letter dated February 10, 2006, pursuant
to which Mr. Buettners reimburse-

53



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##### Table of Contents





As disclosed in the 8-K dated January 23, 2006 filed
by the Company on January 24, 2006, Alison L. May resigned
from her positions as the President and Chief Executive Officer
and as a director of the Company. As disclosed in the 8-K
dated February 17, 2006 filed by the Company on
February 23, 2006, Ms. Mays resignation became
effective on February 21, 2006 upon the appointment of her
successor, Ken Constable. In connection with
Ms. Mays resignation, the Company and Ms. May
entered into a Separation Agreement and General Release dated
March 30, 2006, which provides that the Company will pay
Ms. May severance payments totaling $285,000 and will pay
twelve months of her and her dependents health insurance
coverage in exchange for a general release of any claims against
the Company. In addition, the agreement provides that
Ms. May will provide certain consulting services to the
Company through June 30, 2006 for which the Company will
pay Ms. May a weekly retainer of $1,200 and at the rate of
$150 an hour for each hour of service provided in excess of
8 hours per week. All unvested stock options held by
Ms. May will continue to vest until the completion of such
consulting relationship. The foregoing description of the
Separation Agreement and General Release is qualified in its
entirety by reference to the provisions of the Separation
Agreement and General Release attached as Exhibit 10.57 to
this annual report on Form 10-K.

On June 14, 2006, the Compensation Committee of the Board
of Directors adopted the Companys Fiscal 2007 Bonus Plan.
The bonus plan provides for a bonus pool to be funded by 30% of
the excess earnings of the Companys fiscal 2007 results
above a specified target subject to certain limitations and
caps. The bonus plan provides that the bonus pool would be
allocated among certain of the Companys employees,
including its executive officers, according to a system of
target incentives, which are calculated as percentages of such
employees base salaries and which increase with position
levels. The foregoing description of the Fiscal 2007 Bonus Plan
is qualified in its entirety by reference to the provisions of
the Fiscal 2007 Bonus Plan attached as Exhibit 10.58 to
this annual report on Form 10-K.

On June 26, 2006, the Company entered into a Loan and
Security Agreement with Wells Fargo Retail Finance, LLC pursuant
to which Wells Fargo Retail Finance, LLC will provide to the
Company a revolving credit facility in a principal amount equal
to the lesser of $12,500,000 or an amount that is equal to the
aggregate of a percentage of the Companys eligible credit
card receivables plus the lesser of a percentage of the cost of
the Companys eligible inventory, net of inventory
reserves, if any, or a percentage of the net retail liquidation
value of the Companys eligible inventory. Interest will
accrue on amounts borrowed under the credit facility at the
prime lending rate or a LIBOR rate plus an applicable margin.
The Companys obligations under the Loan and Security
Agreement are secured by a security interest in substantially
all of the tangible and intangible assets of the Company (the
Collateral).

The Loan and Security Agreement sets forth certain affirmative
covenants that require the Company to, among other things,
maintain its insurance policies, maintain its properties and the
Collateral in good order, pay its taxes, comply with applicable
laws, keep accurate and proper books and records of Collateral,
provide access to its records, provide monthly borrowing base
certificates and monthly and annual financial reports, and cause
the undertaking of certain inventories, appraisals and audits of
the Collateral. The Loan and Security Agreement also contains
negative covenants that limit the ability of the Company, except
as set forth therein, to, among other things, enter into or
materially amend (other than renewals or extensions) any of its
real property leases, place any of the Collateral with any third
party (other than the sale of merchandise in the ordinary course
of business and as otherwise set forth in the agreement), incur
additional indebtedness, create any liens or encumbrances on any
of its collateral, make certain investments, make any loans or
advances and engage in certain transactions with affiliates. The
Loan and Security Agreement also contains a covenant that
prohibits us from paying cash dividends to our stockholders. In
addition, the Loan and Security Agreement requires the Company
to maintain availability under the credit facility of at least
12.5% of the then extant revolving credit loan ceiling.

54



---



##### Table of Contents



The Loan and Security Agreement contains certain events of
default, including but not limited to the Companys failure
to make payments under the Loan and Security Agreement, the
Companys failure to extend or renew the lease agreement
for the Companys distribution center in Lockbourne, Ohio,
a material breach of the representations and warranties, or a
failure to comply with the covenants contained in the Loan and
Security Agreement, the acceleration of any other indebtedness
of the Company, the occurrence of an event of default under any
agreement between the Company and the lender, an uninsured loss
to a material portion of the Collateral, the imposition of, or
entry of judgment against the Company in, certain legal
proceedings, bankruptcy or receivership and the occurrence of a
liquidation or change in control of the Company. Upon the
occurrence and during the continuance of an event of default,
the lender may declare all of the Companys obligations
under the Loan and Security Agreement immediately due and
payable (provided, however, that if the event of default is
triggered by the institution of bankruptcy proceedings against
the Company, all of the Companys obligations under the
Loan and Security Agreement shall immediately become due and
payable).

The foregoing description of the Loan and Security Agreement is
qualified in its entirety by reference to the provisions of the
Loan and Security Agreement attached as Exhibit 10.59 to
this annual report on Form 10-K.




PART III






|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant

Information regarding our Executive Officers required hereunder
is set forth in Item 1 of Part 1
Business  Executive Officers of the
Registrant. The information required hereunder regarding
our Directors is incorporated by reference from our Proxy
Statement to be filed in connection with our 2006 Annual Meeting
of Stockholders. The information required hereunder regarding
Compliance with Section 16(a) of the Securities Exchange
Act and our Code of Ethics is incorporated by reference from our
Proxy Statement to be filed in connection with our 2006 Annual
Meeting of Stockholders.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our 2006
Annual Meeting of Stockholders.






|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters

The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our 2006
Annual Meeting of Stockholders.






|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions

The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our 2006
Annual Meeting of Stockholders.






|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accountant Fees and Services

The information required hereunder is incorporated by reference
from our Proxy Statement to be filed in connection with our 2006
Annual Meeting of Stockholders.

55



---



##### Table of Contents






PART IV






|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

Documents filed as a part of the report:



| |                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. Financial Statements                                                                                                                                                      
|
| | The following consolidated financial statements of the Company
    are included in Item 8:                                                                                   
|
| | Report of Independent Registered Public Accounting Firm                                                                                                                      
|
| | Balance Sheets                                                                                                                                                               
|
| | Statements of Operations                                                                                                                                                     
|
| | Statements of Stockholders Equity (Deficit)                                                                                                                                 
|
| | Statements of Cash Flows                                                                                                                                                     
|
| | Notes to Financial Statements                                                                                                                                                
|
| | 2. Financial Statement Schedules                                                                                                                                             
|
| | All schedules have been omitted because they are inapplicable,
    not required or the information is included in the Consolidated
    Financial Statements or Notes thereto.
|
| | 3. Exhibits                                                                                                                                                                  

|       |    |             |  |                                                                                                                                                                                                                
|------ | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 3  | .2          |  | Amended and Restated Certificate of Incorporation
    of the Registrant(1)                                                                                                                                     
|       | 3  | .4          |  | Amended and Restated Bylaws of the Registrant.(1)                                                                                                                                                              
|       | 4  | .1          |  | Specimen stock certificate for the
    Registrants common stock.(1)                                                                                                                                           
|       | 4  | .2          |  | Amended and Restated Investors Rights
    Agreement dated April 17, 2002 between the Registrant and
    certain investors.(1)                                                                                 
|       | 4  | .3          |  | Omnibus Amendment to Investors Rights
    Agreement, Right of First Refusal and Co-Sale Agreement and
    Voting Agreement dated May 29, 2003 between the Registrant
    and certain investors.(1)            
|       | 4  | .9          |  | Warrant Agreement dated February 10, 2000
    issued to Comdisco, Inc.(1)                                                                                                                                      
|       | 4  | .10         |  | Restricted Stock Award Agreement with Kenneth
    Constable dated March 1, 2006 (incorporated by reference to
    Exhibit 4.1 to the Companys Registration Statement on Form
    S-8 filed February 28, 2006).
|       | 4  | .11         |  | Stock Option Agreement, dated March 3, 2006, with
    Frank Buettner (incorporated by reference to Exhibit 4.3 to the
    Companys Current Report on Form 8-K filed May 31, 2006).                            
|       | 10 | .10         |  | Lease dated March 28, 2000 between
    RedEnvelope and Four Amigos.(1)                                                                                                                                         
|       | 10 | .11         |  | First Amendment to Lease Agreement between The
    Four Amigos, a California Limited Partnership, and
    RedEnvelope, Inc., dated as of January 1, 2004. (3)                                                  
|       | 10 | .12         |  | Offer Letter to Alison May dated March 12,
    2002.(1)                                                                                                                                                        
|       | 10 | .13         |  | Indemnification Agreement between RedEnvelope and
    Alison May dated April 8, 2002.(1)                                                                                                                       
|       | 10 | .20         |  | 1999 Stock Plan, as amended on April 11,
    2003, and form agreements thereunder.(1)                                                                                                                          
|       | 10 | .21         |  | 2003 Directors Stock Option Plan and form
    agreements thereunder.(1)                                                                                                                                       
|       | 10 | .22         |  | 2003 Employee Stock Purchase Plan and form
    agreements thereunder.(1)                                                                                                                                       
|       | 10 | .37*        |  | Software License, Services, Support and
    Enhancements Agreement dated December 29, 2003 between
    RedEnvelope, Inc. and Manhattan Associates, Inc.(2)                                                     

56



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##### Table of Contents



|       |    |             |  |                                                                                                                                                                                                                                                                                   
|------ | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 10 | .39         |  | Lease Agreement between Creekside III LLC and
    RedEnvelope, Inc. effective as of April 1, 2004
    (incorporated by reference to Exhibit 99.1 to the
    Companys Current Report on Form 8-K filed
    November 22, 2004).                                                    
|       | 10 | .40         |  | Lease Agreement dated July 22, 2004 between 149 New
    Montgomery, LLC and RedEnvelope, Inc. (incorporated by
    reference to the identically numbered exhibit to the
    Companys Quarterly Report on Form 10-Q for the period
    ended June 27, 2004).                      
|       | 10 | .43         |  | Employment Agreement dated August 20, 2004 between Kristine Dang
    and RedEnvelope, Inc. (incorporated by reference to the
    identically numbered exhibit to the Companys Quarterly
    Report on Form 10-Q for the period ended September 26, 2004).                        
|       | 10 | .44         |  | Employment Agreement dated December 22, 2004 between Gary
    Korotzer and RedEnvelope, Inc. (incorporated by reference
    to the identically numbered exhibit to the Companys
    Quarterly Report on Form 10-Q for the period ended
    December 26, 2004).                   
|       | 10 | .45         |  | Employment offer letter dated March 28, 2005 between
    RedEnvelope, Inc. and Polly Boe (incorporated by reference
    to the identically numbered exhibit to the Companys
    Current Report on Form 8-K filed March 31, 2005).                                                
|       | 10 | .46         |  | Employment Offer Letter dated October 7, 2003 between
    RedEnvelope, Inc. and Christopher Nordquist.                                                                                                                                                                            
|       | 10 | .50*        |  | License Agreement between Harrison 160, LLC and
    RedEnvelope, Inc., dated as of May 31, 2005. (3)                                                                                                                                                                              
|       | 10 | .51         |  | Second Amendment to Lease Agreement between The Four Amigos, a
    California Limited Partnership, and RedEnvelope, Inc.,
    dated as of January 25, 2005 (incorporated by reference to
    Exhibit 99.1 to the Companys Current Report on
    Form 8-K filed January 28, 2005).
|       | 10 | .52         |  | Agreement between Scott Galloway and RedEnvelope, Inc.
    dated July 13, 2005 (incorporated by reference to
    Exhibit 10.1 to the Companys Current Report on Form
    8-K filed on July 15, 2005).                                                                            
|       | 10 | .53         |  | Form of Indemnification Agreement for Executive Officers and
    Directors (in use from August 15, 2005) (incorporated by
    reference to Exhibit 10.53 to the Companys Quarterly
    Report of Form 10-Q for the period ended July 3, 2005).                                   
|       | 10 | .54         |  | Employment Agreement dated February 18, 2006 between
    RedEnvelope, Inc. and Ken Constable (incorporated by reference
    to Exhibit 10.54 of the Companys Current Report on Form
    8-K filed February 23, 2006).                                                            
|       | 10 | .55         |  | Employment offer letter dated February 10, 2006 between
    RedEnvelope, Inc. and Frank Buettner (incorporated by reference
    to Exhibit 10.55 to the Companys Current Report on Form
    8-K filed February 23, 2006).                                                        
|       | 10 | .56         |  | Separation Agreement and General Release between RedEnvelope,
    Inc. and Kristine Dang, dated January 23, 2006.                                                                                                                                                                 
|       | 10 | .57         |  | Separation Agreement and General Release between RedEnvelope,
    Inc. and Alison May, dated March 30, 2006.                                                                                                                                                                      
|       | 10 | .58         |  | RedEnvelope, Inc. Fiscal 2007 Bonus Plan.                                                                                                                                                                                                                                         
|       | 10 | .59         |  | Loan and Security Agreement dated June 26, 2006 between
    RedEnvelope, Inc. and Wells Fargo Retail Finance LLC.                                                                                                                                                                 
|       | 10 | .60         |  | Collateral Assignment of License Agreement dated June 26, 2006
    between RedEnvelope, Inc. and Wells Fargo Retail Finance, LLC.                                                                                                                                                 
|       | 10 | .61         |  | Revolving Credit Note dated June 26, 2006 executed by
    RedEnvelope, Inc.                                                                                                                                                                                                       
|       | 10 | .62**       |  | Fee Letter dated June 26, 2006 between RedEnvelope, Inc. and
    Wells Fargo Retail Finance, LLC.                                                                                                                                                                                 
|       | 10 | .63         |  | Intellectual Property Security Agreement dated June 26, 2006
    between RedEnvelope, Inc. and Wells Fargo Retail Finance, LLC.                                                                                                                                                   
|       | 10 | .64**       |  | Software License and Service Agreement dated March 31, 2000
    between BroadVision, Inc. and RedEnvelope, Inc. (including
    Attachment D-2 thereto dated September 26, 2002 and Attachment
    D-3 thereto dated October 31, 2005).                                            

57



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##### Table of Contents



|       |    |             |  |                                                                                                                                        
|------ | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 23 | .1          |  | Consent of Independent Registered Public Accounting Firm.                                                                              
|       | 24 | .1          |  | Power of Attorney (See Page 59).                                                                                                       
|       | 31 | .1          |  | Ken Constables Certification pursuant to 13a-14(a) as
    adopted pursuant to Section 302 of the Sarbanes-Oxley Act
    of 2002.      
|       | 31 | .2          |  | Polly Boes Certification pursuant to 13a-14(a) as adopted
    pursuant to Section 302 of the Sarbanes-Oxley
    Act of 2002.          
|       | 32 | .1          |  | Ken Constables Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.
|       | 32 | .2          |  | Polly Boes Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.    



---



|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to identically numbered exhibits to
    the Companys Registration Statement on Form S-1,
    which became effective on September 24, 2003.
|   
|(2) | Incorporated by reference to identically numbered exhibits to
    the Companys Annual Report on Form 10-K for the
    period ended March 28, 2004.                  
|   
|(3) | Incorporated by reference to identically numbered exhibits to
    the Companys Annual Report of Form 10-K for the
    period ending April 3, 2005.                  



| |   |                                                                                     
| | - | ------------------------------------------------------------------------------------
| | * | Confidential treatment granted with respect to certain portions
    of this Exhibit.



|   |                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | Material has been omitted pursuant to a request for confidential
    treatment. Omitted portions have been filed separately with the
    Securities and Exchange Commission.

58



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized as of June 29, 2006.



| |                  
| | -----------------
| | REDENVELOPE, INC.



| |     |              
| | --- | -------------
| | By: | /s/ Polly Boe

| |                        
| | -----------------------
| |                        
| | Polly Boe              
| | Chief Financial Officer



KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Kenneth Constable and
Polly Boe, and each of them, his or her attorney-in-fact with
power of substitution for him or her in any and all capacities,
to sign any amendments, supplements or other documents relating
to this Annual Report on Form 10-K they deem necessary or
appropriate, and to file the same, with exhibits thereto, and
other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that
such attorney-in-fact or his substitute may do or cause to be
done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.

|                                         |  |                                                                                       |  |               |  | 
|---------------------------------------- |  | ------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                         |  |                                                                                       |  |              
|Signature                                |  | Title                                                                                 |  | Date         
|                                         |  |                                                                                       |  |              
|                                        
|/s/ Daniel R. LyleDaniel R. Lyle         |  | Chairman of the Board                                                                 |  | June 29, 2006
|                                        
|/s/ Kenneth ConstableKenneth Constable   |  | Director, President and
    Chief Executive Officer
    (Principal Executive Officer) |  | June 29, 2006
|                                        
|/s/ Polly BoePolly Boe                   |  | Chief Financial Officer
    (Principal Financial and
    Accounting Officer)          |  | June 29, 2006
|                                        
|/s/ Michael E. DunnMichael E. Dunn       |  | Director                                                                              |  | June 29, 2006
|                                        
|/s/ Karen EdwardsKaren Edwards           |  | Director                                                                              |  | June 29, 2006
|                                        
|/s/ Joseph C. GandolfoJoseph C. Gandolfo |  | Director                                                                              |  | June 29, 2006
|                                        
|/s/ Greggory HammannGreggory Hammann     |  | Director                                                                              |  | June 29, 2006

59



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##### Table of Contents



|                                       |  |          |  |               |  | 
|-------------------------------------- |  | -------- |  | ------------- |  | 
|                                       |  |          |  |              
|Signature                              |  | Title    |  | Date         
|                                       |  |          |  |              
|                                      
|/s/ Charles HeilbronnCharles Heilbronn |  | Director |  | June 29, 2006
|                                      
|/s/ Brett HendricksonBrett Hendrickson |  | Director |  | June 29, 2006
|                                      
|/s/ John PoundJohn Pound               |  | Director |  | June 29, 2006
|                                      
|Scott Galloway                         |  | Director |  |              

60



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##### Table of Contents



EXHIBIT INDEX

|       |    |             |  |                                                                                                                                                                                                                                                                                       
|------ | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 3  | .2          |  | Amended and Restated Certificate of Incorporation
    of the Registrant(1)                                                                                                                                                                                                            
|       | 3  | .4          |  | Amended and Restated Bylaws of the Registrant.(1)                                                                                                                                                                                                                                     
|       | 4  | .1          |  | Specimen stock certificate for the
    Registrants common stock.(1)                                                                                                                                                                                                                  
|       | 4  | .2          |  | Amended and Restated Investors Rights
    Agreement dated April 17, 2002 between the Registrant and
    certain investors.(1)                                                                                                                                                        
|       | 4  | .3          |  | Omnibus Amendment to Investors Rights
    Agreement, Right of First Refusal and Co-Sale Agreement and
    Voting Agreement dated May 29, 2003 between the Registrant
    and certain investors.(1)                                                                                   
|       | 4  | .9          |  | Warrant Agreement dated February 10, 2000
    issued to Comdisco, Inc.(1)                                                                                                                                                                                                             
|       | 4  | .10         |  | Restricted Stock Award Agreement with Kenneth
    Constable dated March 1, 2006 (incorporated by reference to
    Exhibit 4.1 to the Companys Registration Statement on Form
    S-8 filed February 28, 2006).                                                                       
|       | 4  | .11         |  | Stock Option Agreement, dated March 3, 2006, with
    Frank Buettner (incorporated by reference to Exhibit 4.3 to the
    Companys Current Report on Form 8-K filed May 31, 2006).                                                                                                   
|       | 10 | .10         |  | Lease dated March 28, 2000 between
    RedEnvelope and Four Amigos.(1)                                                                                                                                                                                                                
|       | 10 | .11         |  | First Amendment to Lease Agreement between The
    Four Amigos, a California Limited Partnership, and
    RedEnvelope, Inc., dated as of January 1, 2004. (3)                                                                                                                         
|       | 10 | .12         |  | Offer Letter to Alison May dated March 12,
    2002.(1)                                                                                                                                                                                                                               
|       | 10 | .13         |  | Indemnification Agreement between RedEnvelope and
    Alison May dated April 8, 2002.(1)                                                                                                                                                                                              
|       | 10 | .20         |  | 1999 Stock Plan, as amended on April 11,
    2003, and form agreements thereunder.(1)                                                                                                                                                                                                 
|       | 10 | .21         |  | 2003 Directors Stock Option Plan and form
    agreements thereunder.(1)                                                                                                                                                                                                              
|       | 10 | .22         |  | 2003 Employee Stock Purchase Plan and form
    agreements thereunder.(1)                                                                                                                                                                                                              
|       | 10 | .37*        |  | Software License, Services, Support and
    Enhancements Agreement dated December 29, 2003 between
    RedEnvelope, Inc. and Manhattan Associates, Inc.(2)                                                                                                                            
|       | 10 | .39         |  | Lease Agreement between
    Creekside III LLC and RedEnvelope, Inc. effective
    as of April 1, 2004 (incorporated by reference to
    Exhibit 99.1 to the Companys Current Report on
    Form 8-K filed November 22, 2004).                                                        
|       | 10 | .40         |  | Lease Agreement dated July 22, 2004 between
    149 New Montgomery, LLC and RedEnvelope, Inc.
    (incorporated by reference to the identically numbered exhibit
    to the Companys Quarterly Report on Form 10-Q for the
    period ended June 27, 2004).                          
|       | 10 | .43         |  | Employment Agreement dated August 20, 2004
    between Kristine Dang and RedEnvelope, Inc. (incorporated by
    reference to the identically numbered exhibit to the
    Companys Quarterly Report on Form 10-Q for the period
    ended September 26, 2004).                        
|       | 10 | .44         |  | Employment Agreement dated December 22, 2004
    between Gary Korotzer and RedEnvelope, Inc. (incorporated
    by reference to the identically numbered exhibit to the
    Companys Quarterly Report on Form 10-Q for the period
    ended December 26, 2004).                       
|       | 10 | .45         |  | Employment offer letter dated March 28, 2005
    between RedEnvelope, Inc. and Polly Boe (incorporated by
    reference to the identically numbered exhibit to the
    Companys Current Report on Form 8-K filed
    March 31, 2005).                                                
|       | 10 | .46         |  | Employment Offer Letter dated October 7, 2003
    between RedEnvelope, Inc. and Christopher Nordquist.                                                                                                                                                                                
|       | 10 | .50*        |  | License Agreement between
    Harrison 160, LLC and RedEnvelope, Inc., dated as
    of May 31, 2005. (3)                                                                                                                                                                              
|       | 10 | .51         |  | Second Amendment to Lease Agreement between The
    Four Amigos, a California Limited Partnership, and
    RedEnvelope, Inc., dated as of January 25, 2005
    (incorporated by reference to Exhibit 99.1 to the
    Companys Current Report on Form 8-K filed
    January 28, 2005).
|       | 10 | .52         |  | Agreement between Scott Galloway and
    RedEnvelope, Inc. dated July 13, 2005 (incorporated by
    reference to Exhibit 10.1 to the Companys Current
    Report on Form 8-K filed on July 15, 2005).                                                                                



---



##### Table of Contents



|       |    |             |  |                                                                                                                                                                                                                                                
|------ | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 10 | .53         |  | Form of Indemnification Agreement for Executive Officers and
    Directors (in use from August 15, 2005) (incorporated by
    reference to Exhibit 10.53 to the Companys Quarterly
    Report of Form 10-Q for the period ended July 3, 2005).
|       | 10 | .54         |  | Employment Agreement dated February 18, 2006 between
    RedEnvelope, Inc. and Ken Constable (incorporated by reference
    to Exhibit 10.54 of the Companys Current Report on Form
    8-K filed February 23, 2006).                         
|       | 10 | .55         |  | Employment offer letter dated February 10, 2006 between
    RedEnvelope, Inc. and Frank Buettner (incorporated by reference
    to Exhibit 10.55 to the Companys Current Report on Form
    8-K filed February 23, 2006).                     
|       | 10 | .56         |  | Separation Agreement and General Release between RedEnvelope,
    Inc. and Kristine Dang, dated January 23, 2006.                                                                                                                              
|       | 10 | .57         |  | Separation Agreement and General Release between RedEnvelope,
    Inc. and Alison May, dated March 30, 2006.                                                                                                                                   
|       | 10 | .58         |  | RedEnvelope, Inc. Fiscal 2007 Bonus Plan.                                                                                                                                                                                                      
|       | 10 | .59         |  | Loan and Security Agreement dated June 26, 2006 between
    RedEnvelope, Inc. and Wells Fargo Retail Finance LLC.                                                                                                                              
|       | 10 | .60         |  | Collateral Assignment of License Agreement dated June 26, 2006
    between RedEnvelope, Inc. and Wells Fargo Retail Finance, LLC.                                                                                                              
|       | 10 | .61         |  | Revolving Credit Note dated June 26, 2006 executed by
    RedEnvelope, Inc.                                                                                                                                                                    
|       | 10 | .62**       |  | Fee Letter dated June 26, 2006 between RedEnvelope, Inc. and
    Wells Fargo Retail Finance, LLC.                                                                                                                                              
|       | 10 | .63         |  | Intellectual Property Security Agreement dated June 26, 2006
    between RedEnvelope, Inc. and Wells Fargo Retail Finance, LLC.                                                                                                                
|       | 10 | .64**       |  | Software License and Service Agreement dated March 31, 2000
    between BroadVision, Inc. and RedEnvelope, Inc. (including
    Attachment D-2 thereto dated September 26, 2002 and Attachment
    D-3 thereto dated October 31, 2005).         
|       | 23 | .1          |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                      
|       | 24 | .1          |  | Power of Attorney (See Page 59).                                                                                                                                                                                                               
|       | 31 | .1          |  | Ken Constables Certification pursuant to 13a-14(a) as
    adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                                              
|       | 31 | .2          |  | Polly Boes Certification pursuant to 13a-14(a) as adopted
    pursuant to Section 302 of the Sarbanes-Oxley Act
    of 2002.                                                                                                                  
|       | 32 | .1          |  | Ken Constables Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                        
|       | 32 | .2          |  | Polly Boes Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                            



---



|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to identically numbered exhibits to
    the Companys Registration Statement on Form S-1,
    which became effective on September 24, 2003.
|   
|(2) | Incorporated by reference to identically numbered exhibits to
    the Companys Annual Report on Form 10-K for the
    period ended March 28, 2004.                  
|   
|(3) | Incorporated by reference to identically numbered exhibits to
    the Companys Annual Report of Form 10-K for the
    period ending April 3, 2005.                  



| |   |                                                                                     
| | - | ------------------------------------------------------------------------------------
| | * | Confidential treatment granted with respect to certain portions
    of this Exhibit.



|   |                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | Material has been omitted pursuant to a request for confidential
    treatment. Omitted portions have been filed separately with the
    Securities and Exchange Commission.